The contagion effect of natural disasters in the Sovereign CDS market: Which causes?

This study investigates the contagion effect of natural disasters on credit default swap (CDS) spreads in the European Union (EU) using a Generalized Method of Moments (GMM) approach. Focusing on understanding the channels through which contagion occurs, we analyze data from 11 Eurozone countries from 2007 to 2021. The analysis explores the causes of the propagation impact of natural disasters on CDS spreads, considering factors such as geographical distance, financial investment flow, and trade balance. Our findings highlight a significant positive effect of natural disasters on CDS spreads, indicating heightened perceived spillover risk following such events. Furthermore, we observe that countries with higher Climate Change Performance Index (CCPI) scores exhibit a lower contagion effect, suggesting that climate commitment may mitigate the financial impact of natural disasters. These results underscore the importance of proactive climate policies and risk management strategies in enhancing financial stability in the face of environmental shocks. • We analyze the credit risk spillover due to natural hazards. • We identify geographical, financial, and economic pathways as key mechanisms amplifying risk transmission. • We highlight that strong climate policies significantly reduce financial contagion.