This paper provides a detailed investigation on how firms’ carbon emission levels affect trading behaviors of institutional investors and liquidity conditions of corporate bonds. Our analysis is conducted with a full sample from 2007 to 2019 and causality is further established by exploiting two carbon-related shocks: the Paris Agreement and the election of U.S. President Trump. We find that both mutual funds and insurance companies are more likely to sell corporate bonds in herds if the bonds’ issuing firms have higher carbon emissions. We show that mutual fund flows negatively respond to the fund carbon exposures and that mutual funds are more likely to sell high-carbon bonds in the face of investor redemptions. We also find that bonds issued by high-carbon firms experience worse liquidity conditions. 

Keywords: Carbon emissions, corporate bonds, mutual funds, insurance companies, herding, redemption, liquidity

JEL Classification: G11, G20, G23, G41​