Rain or Shine, Default Risks Align: Exploring the Climate-Default Nexus in Small and Micro Firms

We investigate the impact of escalating temperature and heavy rainfall on the default probability of small and micro enterprises (SMiEs) in six European countries from 2005 to 2014. Our findings reveal that a one standard deviation increase (2.56°C) in the yearly mean temperature amplifies a firm's default probability by 86.5 basis points. Additionally, a one standard deviation increase (2.46mm) in the Simple Precipitation Intensity Index increases the default probability by 32.4 basis points. We argue that one channel explaining the adverse impact of climate risk on default probability is labour productivity loss. In addition, micro and financially constrained firms demonstrate an increased susceptibility to these risks. Further, when the ultimate owner also serves as the firm's manager, they can mitigate the adverse effects of rising temperature and heavy rainfall.

Keywords: climate risk, physical risk, credit risk, SMEs JEL: G30, G33

JEL Classification: G30, G33

Suggested Citation: Suggested Citation

Cathcart, Lara and Ding, Zhenghong and Dufour, Alfonso and Rossi, Ludovico and Varotto, Simone, Rain or Shine, Default Risks Align: Exploring the Climate-Default Nexus in Small and Micro Firms (July 16, 2023). Available at SSRN: https://ssrn.com/abstract=4512185 or http://dx.doi.org/10.2139/ssrn.4512185