The impact of climate risk on sovereign debt: Evidence from OECD economies

This study investigates whether financial markets incorporate climate transition risk into sovereign bond pricing. Using a panel of 31 OECD economies over the period 2001-2020, we decompose the ND-GAIN Index to isolate specific transmission channels. Our results reveal that investors act as sophisticated evaluators of environmental management capacity. Consistent with the credit enhancement hypothesis, robust institutional and structural capacity is rewarded with lower borrowing costs, signalling policy credibility. Conversely, extensive social adaptation requirements exhibit an ambiguous or positive association with yields. This suggests that markets price the associated welfare commitments as sources of fiscal constraint rather than as an immediate resilience asset, potentially reflecting a tension between the long-term benefits of social resilience and the short-term fiscal rigidity required to fund it. These findings highlight that without credible fiscal strategies, the social costs of the green transition may generate a risk premium rather than a discount. • We examine the impact of climate risk on long-term sovereign bond interest rates. • We assess whether investors incorporate climate-related factors into their decision-making processes. • We utilize panel data from 36 OECD economies from 2001 to 2020. • We find the positive impact of climate risk on government borrowing costs. • Investors should account for climate risk when evaluating sovereign debt.