Climate change and the pricing of sovereign debt: Insights from European markets

Abstract

The paper analyses the impact of several climate change metrics (performance, exposure to extreme events, vulnerability, readiness, climate debt) on the cost of government borrowing expressed as both sovereign bond yields and sovereign risk premium, in a panel of European Union countries over 2000–2020. Findings show that climate-vulnerable countries, exhibiting low climate disaster managerial abilities in mitigating the climate challenges pay a higher risk premium on their sovereign debt. Euro-area countries record lower sovereign bond yields and spreads than non-members, while south-eastern European countries face higher sovereign yields and spreads. The classification of countries into different bio-geographic regions, according to observed and projected climate change patterns, shows that Atlantic-region countries experience both lower sovereign bond yields and spreads while Mediterranean countries face higher yields. Results emphasise that countries with lower fiscal space, impaired fiscal and economic indicators have to pay higher yields when issuing sovereign bonds and witness larger spreads.