European Central Bank working paper finds sovereign bond markets price climate transition risk while physical risks show up mainly for high debt countries

The European Central Bank published Working Paper No. 3135 on how climate-related risks are reflected in sovereign bond pricing across 52 advanced and emerging market and developing economies over 2000–2023. Using panel regressions, the paper finds that transition risk, proxied by carbon dioxide emissions per capita, is associated with higher 10-year sovereign yields, with a stronger relationship for emerging market and developing economies and for high-emitting countries after the Paris Agreement. By contrast, chronic physical risk measured by temperature anomalies is not generally priced into sovereign borrowing costs in the full sample. Using EM-DAT natural disaster data and local projection methods, the paper reports heterogeneity in how acute physical shocks affect yields, with effects concentrated in more fiscally constrained settings. Highly indebted countries tend to see higher yields as acute physical risk increases, and yield responses vary by disaster type and severity, with droughts and storms showing the largest short-to-medium-term increases and more immediate, steeper responses in emerging market and developing economies; available fiscal space dampens the magnitude and persistence of the impact. The paper also reports robustness checks using alternative transition-risk proxies, including evidence that higher renewable energy use is associated with lower sovereign yields, and notes that the views expressed are those of the authors rather than the European Central Bank.