Pricing climate transition risk: Evidence from European corporate CDS

Abstract

The European low-carbon transition towards net-zero emissions by 2050 is gaining momentum. This study analyzes a major European firm’s climate-related transition indicators and their impact on CDS-implied credit risk across different time horizons. Results reveal market pricing of transition risk across all tenors, especially since the 2015 Paris Agreement. Carbon-intensive sectors like Electricity, Gas, and Mining face heightened transition risk pricing. Interestingly, the market may undervalue a company’s transition risk management efforts and participation in the EU ETS, possibly due to market inefficiencies. Predicting allowance prices’ impact on financial performance in the EU ETS market is notably challenging due to unique supply–demand dynamics. • This study analyzes firms’ climate transition indicators and CDS credit risk impact. • CDS Market prices transition risk across all tenors, especially post-2015 Paris Agreement. • Carbon-intensive sectors face heightened transition risk pricing in CDS market. • CDS Market does not price ETS exposure; high-emitting ETS firms lack higher CDS spreads.

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