Comment Text:
Expect the worst, hope for the best: The valuation of climate risks and opportunities in sovereign bonds
Bingler, Julia Anna (2022)
CER-ETH working paper
How climate aspects affect sovereign bonds is still a new field of research. I differentiate between transition, physical, and innovation aspects of climate risks and climate performance and estimate the pricing-in of these climate aspects in sovereign bond yields for a sample of 29 countries, for the time 2008-2021. The results show that the effects differ between countries with higher and lower credit rating, long- and short term maturities, and the periods of analysis. Financial markets seem to expect the worst with regards to physical risk exposure and impacts, which are associated with higher yields for the lower-rated countries’ bonds at longer-term maturities. In contrast, they seem to hope for the best with regards to transition risk exposure and innovation opportunities, which are associated with lower bond yields for the countries with higher credit rating, mainly for bonds at shorter-term maturity. The effects are more pronounced for the period after the Paris Agreement and might gain increasing importance as physical and transition risks aggravate in the future.
Non-academic paper summary:
• Analysis of pricing-in of climate risk exposure and climate performance in sovereign bond yields, differentiated by physical risks, transition risks, and innovation opportunities.
• The results show that financial markets started to take climate performance and climate risk exposure into account, yet to varying degrees.
• Effects differ considerably between countries with higher and lower credit rating, bonds with long- and short term maturities, and the period of analysis.
• Physical risks are shown to be primarily priced-in for countries with lower credit rating, and their bonds at longer-term maturities.
• Transition risks and climate innovation opportunities are of importance to higher-rated sovereigns for bonds with shorter-term maturities.
• These effects are stronger for the period after the Paris Agreement.
• Implications for policy and practice:
o Countries with lower credit rating could reduce their bond yields with climate change adaptation strategies to mitigate climate change physical exposure risks.
o Countries with higher credit rating could reduce their bond yields with a stronger climate policy performance and more climate innovation opportunities.
o Investors and financial market actors should take climate risk exposure and climate performance indicators into account to assess the financial health of a country.
Link: Available at ETH research collection https://doi.org/10.3929/ethz-b-000541138 or at SSRN: https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=3755443
