Analyzing the impact of carbon risk on firms' creditworthiness in the context of rising interest rates

Carbon risk, a type of climate risk, is expected to have a crucial impact, especially on high-carbon-emitting, "polluting" firms as opposed to less carbon-intensive, "clean" ones. With a rising number of actions and policies being continuously proposed to mitigate these concerns and an increasing number of investors demanding more climate adaptation initiatives, this transition risk will certainly need to be incorporated into a firm' credit risk assessment. In this paper, we explore the impact of the carbon risk factor, constructed as the daily median difference in default protection between polluting and clean European firms, on firm creditworthiness using quantile regressions on the tail distribution of credit default swap spreads for different maturities between 2020 and 2023. In particular, the recent European interest rate hikes lead to unexpected conclusions about when the carbon risk factor affects firm creditworthiness and how rapidly the net-zero economy transition must occur. Contrary to the previous literature, we find that investors are expecting the transition to occur in the medium-to-long term.