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Climate Policy and Sovereign Debt: The Impact of Transition Scenarios on Sovereign Creditworthiness

Matt Burke, Matthew Agarwala, Patrycja Klusak and Kamiar Mohaddes

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: This paper links climate science with sovereign risk assessment to produce a single forward-looking measure of country-level climate change risk. We combine the Network for Greening the Financial System (NGFS) climate scenarios with a sovereign credit ratings model to simulate the impact of climate change on credit ratings, cost of debt and probability of default. For the first time, we extend beyond the physical risks of extreme weather events to explicitly incorporate risks associated with transitioning the global economy towards Net Zero. Across the sample of 48 countries and under a scenario of high (low) physical and transition risks, we find average downgrades of 3.9 (2.7) notches and mean increases in the cost of debt of 123 (76) basis points and default probability of 10.4% (6.2%). Counter-intuitively, ratings, default probability, and cost of debt appear insensitive to scenarios in some countries, with important implications for the usefulness of NGFS scenarios across central banks.

Keywords: Climate Policy; Credit Ratings; Sovereign debt; Transition Risks (search for similar items in EconPapers)
JEL-codes: C53 E60 G20 H63 Q51 Q54 (search for similar items in EconPapers)
Date: 2024-12-13
New Economics Papers: this item is included in nep-ene and nep-env
Note: km418
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Working Paper: Climate Policy and Sovereign Debt: The Impact of Transition Scenarios on Sovereign Creditworthiness (2024) Downloads
Working Paper: Climate Policy and Sovereign Debt: The Impact of Transition Scenarios on Sovereign Creditworthiness (2024) Downloads
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