Climate Default Swap – Disentangling the Exposure to Transition Risk Through CDS

38 Pages Posted: 3 Jun 2021

See all articles by Alexander Blasberg

Alexander Blasberg

University of Duisburg-Essen

Ruediger Kiesel

University of Duisburg-Essen - Faculty of Economic Science

Luca Taschini

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment; University of Edinburgh Business School; University of Verona - Department of Economics

Date Written: May 31, 2021

Abstract

The substantial economic transformation required to mitigate and adapt to climate change will lower the value of certain businesses as well as some firms' assets in the not-too-distant future. Firms will need to transition to a less carbon-intensive business model, but may do so at different times and at different speeds, incurring different costs and risks in the process. We propose and implement a novel market-based measure of exposure to transition risk (transition risk factor) and examine how this risk affects firms' creditworthiness. We discipline the exercise by using Credit Default Swap (CDS) spreads to capture differential exposure to transition risk across economic sectors. We show that the transition risk factor is a relevant determinant of CDS spreads and provide evidence of the relationship between the differential exposure to transition risk and firms' cost of default protection. This effect is particularly pronounced during deteriorating credit market movements. However, effects vary substantially across industries, reflecting the fact that transition risk impacts firms' valuation differently depending on their sector. Our findings also suggest that investors seek greater protection against transition risks in the short– to medium-term, indicating an expectation of a swift transformation of the entire economic structure.

Keywords: Climate Change, Transition Risk, Credit Risk, CDS Spreads

JEL Classification: C21, C23, G12, G32, Q54

Suggested Citation

Blasberg, Alexander and Kiesel, Ruediger and Taschini, Luca, Climate Default Swap – Disentangling the Exposure to Transition Risk Through CDS (May 31, 2021). Available at SSRN: https://ssrn.com/abstract=3856993 or http://dx.doi.org/10.2139/ssrn.3856993

Alexander Blasberg (Contact Author)

University of Duisburg-Essen

Universitätsstraße 2
Essen, NRW 45141
Germany

Ruediger Kiesel

University of Duisburg-Essen - Faculty of Economic Science ( email )

Essen, 45117
Germany

HOME PAGE: http://www.lef.wiwi.uni-due.de/

Luca Taschini

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment ( email )

Houghton Street
London, WC2A 2AE
Great Britain

University of Edinburgh Business School

29 Buccleuch Pl
Edinburgh, Edinburgh EH8 9JS
United Kingdom

University of Verona - Department of Economics ( email )

Via Cantarane 24
Verona, Verona 37129
Italy

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