Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness

Klusak, Patrycja, Agarwala, Matthew, Burke, Matt, Kraemer, Moritz and Mohaddes, Kamiar (2023) Rising temperatures, falling ratings: The effect of climate change on sovereign creditworthiness. Management Science, 69 (12). pp. 7468-7491. ISSN 0025-1909

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Enthusiasm for “greening the financial system” is welcome, but a fundamental challenge remains: financial decision makers lack the necessary information. It is not enough to know that climate change is bad. Markets need credible, digestible information on how climate change translates into material risks. To bridge the gap between climate science and real-world financial indicators, we simulate the effect of climate change on sovereign credit ratings for 109 countries, creating the world’s first climate-adjusted sovereign credit rating. Under various warming scenarios, we find evidence of climate-induced sovereign downgrades as early as 2030, increasing in intensity and across more countries over the century. We find strong evidence that stringent climate policy consistent with limiting warming to below 2 ◦C, honoring the Paris Climate Agreement and following representative concentration pathway (RCP) 2.6, could nearly eliminate the effect of climate change on ratings. In contrast, under higher emissions scenarios (i.e., RCP 8.5), 59 sovereigns experience climate-induced downgrades by 2030, with an average reduction of 0.68 notches, rising to 81 sovereigns facing an average downgrade of 2.18 notches by 2100. We calculate the effect of climate-induced sovereign downgrades on the cost of corporate and sovereign debt. Across the sample, climate change could increase the annual interest payments on sovereign debt by US$45–$67 billion under RCP 2.6, rising to US$135–$203 billion under RCP 8.5. The additional cost to corporations is US$10–$17 billion under RCP 2.6 and US$35–$61 billion under RCP 8.5.

Item Type: Article
Additional Information: Funding Information: M. Agarwala, P. Klusak, and M. Burke acknowledge funding from the International Network for Sustainable Financial Policy Insights, Research and Exchange (INSPIRE). M. Agarwala also acknowledges funding from The Wealth Economy Project. Supplemental Material:The data files and online appendix are available at https:/ /doi.org/10.1287/mnsc. 2023.4869.
Uncontrolled Keywords: climate change,climate-economy models,corporate debt,counterfactual analysis,sovereign credit rating,sovereign debt,strategy and management,management science and operations research,sdg 13 - climate action ,/dk/atira/pure/subjectarea/asjc/1400/1408
Faculty \ School: Faculty of Social Sciences > Norwich Business School
University of East Anglia Research Groups/Centres > Theme - ClimateUEA
UEA Research Groups: Faculty of Social Sciences > Research Groups > Finance Group
Faculty of Social Sciences > Research Centres > Centre for Competition Policy
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Depositing User: LivePure Connector
Date Deposited: 29 Mar 2021 23:57
Last Modified: 23 Jan 2024 01:38
URI: https://ueaeprints.uea.ac.uk/id/eprint/79581
DOI: 10.1287/mnsc.2023.4869


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