The Effect of Climate Risk on Sovereign Debt: Empirical Evidences from Developed Economies

Context/Purpose: Since this is a very large and unprecedented phenomenon, research has long been studying the effects of climate change under various profiles. This study is part of a broad debate with a rich literature and aims to verify the existence of a relationship between the interest rates of long-term sovereign bonds and the climate risk deriving from climate change. Methods The analysis is based on panel data of 33 countries over a period ranging from 2001 to 2020, assembled from the IMF’s and the Organization for Economic Co-operation and Development (OECD) databases. Since the theoretical framework of this study heavily relies on market determined prices as an indicator of economic agents’ expectations, the sample meets certain criteria inherent in homogeneity in terms of economic development of the issuing countries, to ensure that the interactions between supply and demand, which then determines bond prices, make the latter more reliable. Results Our analysis shows the presence of a statistically significant negative relation between climate change resilience and interest rates on government debt. Although the magnitude is relatively small, its existence is particularly relevant because the intensity of the relation should become, in the long run, deeper. In fact, even if the trajectory is difficult to predict, the climate change is a phenomenon inevitably destined to worsen. Interpretation The initial hypothesis is confirmed by our analysis and is consistent with the prevailing literature: investors consider climate risk in their investment choices. Conclusion The research has several important policy implications, mainly concerning the methods of financing and allocation of government spending. In fact, the implementation of mitigation policies would have the advantage of containing the negative physical damage inherent in climate change and would allow borrowing at lower rates. This last aspect, in turn, results in an increase in current and future spending capacity, which is a key element in mitigating climate change.