Sovereign bond spreads and climate risk: An empirical analysis in the Euro Area

Abstract This paper examines whether climate-related factors help explain 10-year sovereign bond spreads in the Euro Area. Unlike previous studies, we employ a novel and comprehensive set of climate indicators capturing both transition and physical climate risks. Using a panel regression with a residual-based approach, we find that climate risk is priced in Euro Area sovereign bond markets, although meaningful cross-country differences remain. In particular, the unexplained component of sovereign spreads appears to react more strongly to forward-looking indicators of carbon dependence and structural climate fragility than to mitigating factors such as institutional preparedness. Overall, financial markets reward credible climate performance and penalize delayed or insufficient transition efforts. Robustness checks and controls for cross-sectional dependence confirm the reliability of our findings.