Brown bonds in a green world: Are investors punishing high-carbon issuers with illiquidity?

• Share of corporate bond funds with green portfolios grew from 10% 2013 to 15% 2024 • There is no evidence that carbon intensity permanently leads to bond illiquidity • High-carbon bonds exhibit short-lived heightened illiquidity around Paris Agreement • Increased share of green funds is not linked to illiquidity in high-carbon bonds • Carbon-intense sectors remain economically attractive to investors We investigate whether corporate bond liquidity is negatively impacted by issuers' carbon intensity, particularly given the rising share of sustainably investing bond funds. Using several established illiquidity measures, we analyze the long-term impact of carbon performance on bond illiquidity. We do not find conclusive evidence that carbon intensity leads to bond illiquidity; however, we find evidence that bonds from high-carbon issuers exhibited heightened illiquidity around the Paris Agreement. A higher share of funds holding low-carbon portfolios does not seem to be associated with improved liquidity in low-carbon bonds. Despite the growing market share of sustainability-oriented funds, continued investment in brown bonds suggests that carbon-intensive sectors remain economically attractive to investors.