https://doi.org/10.52903/wp2025347
DECODING CLIMATE-RELATED RISKS IN SOVEREIGN BOND PRICING: A GLOBAL PERSPECTIVE
Sofia Anyfantaki
European Central Bank and Bank of Greece
Marianna Blix Grimaldi
Sveriges Riksbank
Carlos Madeira
Central Bank of Chile
Simona Malovana
Czech National Bank
Georgios Papadopoulos
Bank of Greece
ABSTRACT
Climate change poses a significant risk to financial stability by impacting sovereign credit risk. Quantifying the exact impact is difficult as climate risk encompasses different components - transition risk and physical risk - with some of these, as well as the policies to address them, playing out over a long-time horizon. In this paper, we use a large panel of 52 developed and developing economies over two decades to empirically investigate the extent to which climate risks influence sovereign yields. The results of a panel regression analysis show that transition risk is associated with higher sovereign yields, with the effect more pronounced for developing economies and for high-emitting countries after the Paris agreement. In contrast, high-temperature anomalies do not appear to be priced-in sovereign borrowing costs. At the same time, countries with high levels of debt tend to record higher sovereign yields as acute physical risk increases. In the medium term, using local projections, we find that sovereign yields respond significantly but also differently to different types of disaster caused by climate change. We also explore the nonlinear effects of weather-related natural disasters on sovereign yields and find a striking contrast in the impact of climate shocks on sovereign borrowing costs according to income level and fiscal space when the shock hits.
Keywords: Climate risk; sovereign risk; transition risk; temperature change; natural disasters
JEL-classifications: C23; E62; H63; Q54
Disclaimer: The project was prepared as part of the research initiative of the International Banking Research Network (IBRN) focused on Climate Risks and Financial Institutions. We gratefully acknowledge the comments and suggestions from Galina Hale, Jon Frost (discussant), the participants of the European Central Bank and Sveriges Riksbank research seminars, the IBRN 2024 Winter Meeting, the 18th International Conference on Computational and Financial Econometrics, the World Bank, and the Inter-American Development Bank. The views expressed are those of the authors and do not necessarily reflect those of the European Central Bank, Sveriges Riksbank, Czech National Bank, the Central Bank of Chile or the Bank of Greece. All errors and omissions are the responsibility of the authors.
Corresponding author:
Sofia Anyfantaki
Directorate General Research, Financial Research Division
European Central Bank
Sonnemannstrasse, 60314, Frankfurt am Main
email: sofia.anyfantaki@ecb.europa.eu