Climate-Linked Bonds

Abstract

Climate-linked bonds, issued by governments and supranational organizations, play a crucial role in achieving a net-zero economy. These bonds adjust their payoffs based on climate variables such as temperature and greenhouse gas levels, offering investors a hedge against long-term climate risks. They also signal government commitment to climate action and incentivize stronger policies. The price differential between climate-linked and nominal bonds reflects market expectations of climate risks. This paper introduces a model of climate hedging and estimates that approximately three percent of government debt in major economies could be converted into climate-linked bonds.

Keywords: climate-linked bonds climate risk, contingent claims, pricing green finance, climate risk

JEL Classification: E58, G12, G13, Q54