Climate-related transition risk in the European CDS market

Abstract

The European low-carbon transition started in the last decades and is accelerating to reach net-zero by 2050. I study how the climate-related transition risk of a European large corporate firm relates to its CDS-implied credit risk for different time horizons. I find that firms with higher GHG emissions have higher CDS-implied credit risk, even at the 30-year horizon, particularly after the 2015 Paris Agreement. The results suggest that the European CDS market is already pricing to some extent the exposure to transition risk of a firm at different time horizons, but ignores a firm’s transition risk management efforts and its exposure to the EU ETS.

Keywords: climate change; transition risk; credit risk; credit default swap (CDS); emissions trading system (ETS)

JEL Classification: E58, G11, G32, Q51, Q56, C58