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

Matilde Faralli () and Francesco Ruggiero ()
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Matilde Faralli: Imperial College London
Francesco Ruggiero: Bank of Italy, Financial Risk Management Directorate

No 62, Mercati, infrastrutture, sistemi di pagamento (Markets, Infrastructures, Payment Systems) from Bank of Italy, Directorate General for Markets and Payment System

Abstract: We investigate the relationship between climate transition risk and credit risk by analyzing firms’ carbon emissions and Moody’s Expected Default Frequencies (EDFs). We find evidence of a structural shift following the Paris Agreement, whereby absolute emissions have become significantly associated with higher EDFs. By decomposing EDFs into their core components, we identify increased asset volatility as the main channel through which transition risk affects credit risk for large emitters. Our analysis illuminates the mechanisms linking climate transition risk to financial risk. The results are robust to various model specifications, control variables, and winsorization thresholds, and suggest that climate-related financial risks are becoming increasingly relevant for credit markets.

Keywords: Climate Change; Credit Risk; EDF; Carbon Emissions; Transition Risk (search for similar items in EconPapers)
JEL-codes: C13 G30 G32 H23 (search for similar items in EconPapers)
Date: 2025-07
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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wpmisp:mip_062_25

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