The Rise of Climate Risks: Evidence on Firms' Expected Default Frequencies

54 Pages Posted: 29 Jun 2022 Last revised: 4 Jan 2023

Date Written: June 23, 2022


This paper studies the relationship between climate risk and credit risk. We find a negative correlation between emission levels and default risk once firm's fixed characteristics are taken into account. By breaking down Moody's Expected Default Frequencies (EDFs) into its main components, we are able to uncover the drivers of this result. First, we show that carbon emissions are relevant for the probability of default, especially through the asset volatility channel. Second, we provide evidence that the 2015 Paris Agreement marked a policy turning point that reverberated on firms’ credit risk. After 2015, our results suggest that firms with high carbon footprints became riskier. We observe that this relation is driven by a decrease (increase) in asset volatility of small (large) emitters. With this analysis, we shed light on the channels through which climate risks affect credit risk, highlighting a number of aspects to consider when including climate risk in credit risk-related analyses.

Keywords: Climate Change, Credit Risk, EDF, Carbon Emissions, Transition Risk

JEL Classification: C12, C21, C23, C31

Suggested Citation

Faralli, Matilde and Ruggiero, Francesco, The Rise of Climate Risks: Evidence on Firms' Expected Default Frequencies (June 23, 2022). Available at SSRN: or

Matilde Faralli

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Francesco Ruggiero (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184

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