The Climate Price Tag: Climate risk in sovereign bond yields and credit ratings

Sammanfattning

This thesis examines whether climate risks are reflected in government bond yields and sovereign credit ratings. Using a panel dataset of 80 advanced and emerging/developing countries over the period 2010-2023, we study seven climate-related variables capturing both transition climate risk and physical climate risk. We estimate two-way fixed-effects regressions to identify determinants of within-country variation over time. We separate effects across country groups, and we examine whether the Paris Agreement of 2015 marked a shift in the incorporation of climate risk. We also compare yield regressions with and without credit ratings as a control variable to assess whether sovereign credit ratings act as a transmission channel between climate risk and borrowing costs. Our results show that climate risk is increasingly reflected in sovereign finance, but unevenly across risk types, country groups, and transmission channels. Renewable energy consumption and participation in international climate treaties are most consistently associated with lower government bond yields, particularly after the Paris Agreement. By contrast, carbon intensity and fossil fuel rents show limited direct pricing in yields but become more strongly associated with lower credit ratings in the post-Paris period. For physical climate risk, temperature change appears to affect advanced country yields partly through credit ratings, while climate disaster frequency shows more direct post-Paris pricing in yields. Overall, our findings suggest that both markets and rating agencies have increasingly incorporated certain climate risks, although this incorporation varies across countries, risk types, and transmission channels.