Do Financial Markets Price Risks to Climate Change?

Abstract

Financial markets represent a powerful means to incentivize governments and corporates to take action against climate change. When climatic risks are reflected in the valuation of financial instruments, firms and governments acting in their own self-interest will reorient decisions toward climate-friendly activities. While the literature has found scant evidence that climate change risks are priced into equity share prices, recent work suggests that climate risks are priced into sovereign bonds. I re-examine the link between climate change and sovereign bonds and find that, as with share prices, sovereign bonds do not price in a climate risk premium. This paper thus resolves the anomalous finding that investors would demand a climate risk premium from sovereign bonds but not stocks. I find that, by virtue of their construction, measures of climate change vulnerability and resilience are highly rigid over time, and thus empirically capture country-specific risk premia rather than a climate-specific risk premium.