Decoding Climate-Related Risks in Sovereign Bond Pricing

This working paper investigates the relationship between climate-related risks and sovereign bond pricing, focusing on a dataset of 52 developed and developing economies over two decades. It identifies two main components of climate risk: transition risk and physical risk. The analysis reveals that transition risk is positively correlated with higher sovereign yields, particularly in developing economies and high-emitting countries, especially following the Paris Agreement. In contrast, the study finds that high-temperature anomalies do not significantly impact sovereign borrowing costs. The paper also highlights that countries with high debt levels experience increased yields as acute physical risks from climate-related disasters rise. The findings suggest that the bond market is increasingly recognizing the implications of climate risks, emphasizing the need for proactive management of these risks to mitigate financial impacts. The study provides empirical evidence on how different types of climate shocks affect sovereign yields, with significant variations based on income levels and fiscal capacity.