Climate Vulnerability and the Cost of Debt

Kling, Gerhard; Lo, Yuen C; Murinde, Victor; Volz, Ulrich

doi:10.2139/ssrn.3198093

Cited by 52 publications

(55 citation statements)

References 14 publications

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“…18 One important concern is whether predicting climate-induced downgrades in the future may increase the cost of debt today. This is particularly concerning for low-income countries where evidence suggests that climaterelated natural disasters are already hitting bond yields (Beirne et al, 2020;Buhr et al, 2018;Kling et al, 2018). If investors believed that e.g., India is not a climate-safe investment, the perverse result could be to starve India of the access to capital it needs to increase resilience.…”

Section: Additional Cost Of Sovereign and Corporate Borrowing Due To mentioning

confidence: 99%

Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

et al. 2021

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Enthusiasm for 'greening the financial system' is welcome, but a fundamental challenge remains: financial decision makers lack the necessary information. It is not enough to know that climate change is bad. Markets need credible, digestible information on how climate change translates into material risks. To bridge the gap between climate science and real-world financial indicators, we simulate the effect of climate change on sovereign credit ratings for 108 countries, creating the world's first climate-adjusted sovereign credit rating. Under various warming scenarios, we find evidence of climate-induced sovereign downgrades as early as 2030, increasing in intensity and across more countries over the century. We find strong evidence that stringent climate policy consistent with limiting warming to below 2°C, honouring the Paris Climate Agreement, and following RCP 2.6 could nearly eliminate the effect of climate change on ratings. In contrast, under higher emissions scenarios (i.e., RCP 8.5), 63 sovereigns experience climateinduced downgrades by 2030, with an average reduction of 1.02 notches, rising to 80 sovereigns facing an average downgrade of 2.48 notches by 2100. We calculate the effect of climate-induced sovereign downgrades on the cost of corporate and sovereign debt. Across the sample, climate change could increase the annual interest payments on sovereign debt by US$ 22-33 billion under RCP 2.

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Section: Additional Cost Of Sovereign and Corporate Borrowing Due To mentioning

confidence: 99%

Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

et al. 2021

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“…If η = 0, as we assume in the baseline calibration, then the interest rate is constant. This modeling choice is justified by evidence suggesting that following a natural disaster, disaster-prone countries lose access to credit markets or see their financing costs skyrocket because their fiscal sustainability is at risk (see, e.g., S&P, 2015, Marto et al, 2018 andKling et al, 2018). Higher interest rates on public debt worsen the fiscal position further making the interest burden larger.…”

Section: Governmentmentioning

confidence: 99%

“…While notches of change in sovereign creditworthiness cannot be linearly translated into changes in interest rates, Marto et al (2018), e.g., assume that a 1.5 notches downgrade implied a 15% increase in the interest paid by the government of Vanuatu following Cyclone Pam in 2015. Kling et al (2018) estimate that countries vulnerable to natural disasters pay, on average, a 1.17% higher cost of debt relative to countries less exposed to climatic events. Given the large uncertainty and the scant literature surrounding the effects of natural disasters on sovereign debt, we take the following approach.…”

Section: An Amplifier: the Sovereign Risk Premiummentioning

confidence: 99%

Macroeconomic Outcomes in Disaster-Prone Countries

Cantelmo¹,

Melina²,

Papageorgiou³

2019

IMF Working Papers

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Using a dynamic stochastic general equilibrium model, we study the channels through which natural disaster shocks affect macroeconomic outcomes and welfare in disaster-prone countries. We solve the model using Taylor projection, a solution method that is shown to deal effectively with high-impact weather shocks calibrated in accordance to empirical evidence. We find large and persistent effects of weather shocks that significantly impact the income convergence path of disaster-prone countries. Relative to non-disaster-prone countries, on average, these shocks cause a welfare loss equivalent to a permanent fall in consumption of 1.6 percent. Welfare gains to countries that self-finance investments in resilient public infrastructure are found to be negligible, and international aid has to be sizable to achieve significant welfare gains. In addition, it is more cost-effective for donors to contribute to the financing of resilience before the realization of disasters, rather than disbursing aid after their realization.

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“…Crifo et al (2017) find that high country's Environmental Social Governance (ESG) ratings are associated with low borrowing costs (spread) for short-maturity sovereign bonds in advanced economics. A different discussion applies to Kling et al (2018), who focus on the most climate vulnerable low-income countries (V20) exposed to climate physical risk. In a few cases the authors find a slightly higher cost of debt.…”

Section: Climate Risks and Financial Evaluationmentioning

confidence: 99%

A Climate Risk Assessment of Sovereign Bonds’ Portfolio

Battiston,

Monasterolo

2019

SSRN Journal

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A climate risk assessment of sovereign bonds' portfolio. PaperOriginal Citation:Monasterolo, Irene ORCID: https://orcid.org/0000-0001-5423-6009 and Battiston, StefanoA climate risk assessment of sovereign bonds' portfolio. AbstractAligning finance to sustainability requires metrics and methods to price forward-looking climate risks and opportunities in financial contracts and in investors' portfolios. Traditional approaches to financial pricing cannot incorporate the nature of climate risks, i.e. deep uncertainty, non-linearity, complexity and endogeneity. To fill this gap, we develop a framework for climate-financial risk assessment and management under uncertainty. We consider a risk averse investor with an information set given by past market valuation, information on future climate economic shocks, and utility maximization based on the minimization of the Climate Value at Risk (VaR) in presence of incomplete markets. We then consider a disorderly policy transition to 2 • C scenarios that leads to unanticipated shocks in economic trajectories of fossil fuel and renewable energy sectors, estimated using Integrated Assessment Models.We model the shock transmission from the change in sectors' Gross Value Added to firms' profitability and to sovereign fiscal revenues. We then introduce the forward-looking climate policy shocks in sovereign bonds valuation introducing scenario-conditioned financial risk metrics (Climate VaR, Climate Spread). We provide an application to OECD sovereign bonds of Austrian National Bank's portfolio. We find that investments' climate alignment can strengthen the sovereign fiscal and financial position by decreasing the climate spread.In contrast, misalignment can negatively affect countries' economic competitiveness and financial stability, and thus the performance of investors who own such bonds. Our analysis supports investors' portfolios risk management strategies in the low-carbon transition and and financial supervisors in the design of prudential risk measures. 1

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Climate Vulnerability and the Cost of Debt

Cited by 52 publications

References 14 publications

Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

Macroeconomic Outcomes in Disaster-Prone Countries

A Climate Risk Assessment of Sovereign Bonds’ Portfolio

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