Climate Transition Risk in Sovereign Bond Markets

Abstract

Is climate transition risk factored into sovereign bond markets? We find that carbon dioxide emissions, natural resources rents, and renewable energy consumption, as measures of transition risk, significantly impact yields and spreads. Countries with lower carbon emissions incur a lower borrowing cost. Advanced countries reducing their earnings from natural resource rents and increasing renewable energy consumption are associated with lower borrowing costs, which differs from the effects in developing countries. Given the threat climate change poses to the global economy and the fast materialisation of transition risk, we advocate an increase in the significance of climate transition risk factors as determinants of sovereign bond markets.

Keywords: climate change, transition risk, sovereign yields, carbon dioxide, natural resources rents, renewables, GDP

JEL Classification: F34, G15, H63, Q20, Q51