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Ask BERT: How Regulatory Disclosure of Transition and Physical Climate Risks Affects the CDS Term Structure

Author

Listed:
  • Julian F Kölbel
  • Markus Leippold
  • Jordy Rillaerts
  • Qian Wang

Abstract

We use BERT, an AI-based algorithm for language understanding, to quantify regulatory climate risk disclosures and analyze their impact on the term structure in the credit default swap (CDS) market. Risk disclosures can either increase or decrease CDS spreads, depending on whether the disclosure reveals new risks or reduces uncertainty. Training BERT to differentiate between transition and physical climate risks, we find that disclosing transition risks increases CDS spreads after the Paris Climate Agreement of 2015, while disclosing physical risks decreases the spreads. In addition, we also find that the election of Trump had a negative impact on CDS spreads for firms exposed to transition risk. These impacts are consistent with theoretical predictions and economically and statistically significant.

Suggested Citation

  • Julian F Kölbel & Markus Leippold & Jordy Rillaerts & Qian Wang, 2024. "Ask BERT: How Regulatory Disclosure of Transition and Physical Climate Risks Affects the CDS Term Structure," Journal of Financial Econometrics, Oxford University Press, vol. 22(1), pages 30-69.
    • Handle: RePEc:oup:jfinec:v:22:y:2024:i:1:p:30-69.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbac027
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    More about this item

    Keywords

    climate risk disclosure; CDS spreads; 10-K filings; physical risks; transition risks; BERT model;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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