Inattention to the Coming Storm? Rising Seas and Sovereign Credit Risk

Abstract

Coastal flooding disasters, exacerbated by future sea level rise (SLR) and population growth, are a threat to low-lying regions. Using sovereign credit default swap spreads as premiums that incorporate information on credit quality, I observe that the long-term credit risk of sovereigns exposed to ex-ante coastal flooding hazard rises by 80 basis points with a one-standard-deviation increase in media attention to climate summits. I also document that the credit market incorporates the changing vulnerability of areas, based on trends in historical population growth, into its risk assessment contemporaneously with attention. The market then shifts, in the subsequent months, to account for adverse trends in coastal flooding exposure under projections of SLR and population growth. In- and out-of-sample predictability tests imply that the market is a laggard in integrating the hazard, reflecting a behavioral inattention to climate information.

Keywords: Climate change, Credit default swaps, Sovereign risk, Investor attention, Sea level rise.

JEL Classification: Q54; G12; G15; D83