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Climate Defaults and Financial Adaptation

Author

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  • Toan Phan
  • Felipe Schwartzman

Abstract

We analyze the relationship between climate-related disasters and sovereign debt crises using a model with capital accumulation, sovereign default, and disaster risk. We find that disaster risk and default risk together lead to slow post-disaster recovery and heightened borrowing costs. Calibrating the model to Mexico, we find that the increase in cyclone risk due to climate change leads to a welfare loss equivalent to a permanent 1% consumption drop. However, financial adaptation via catastrophe bonds and disaster insurance can reduce these losses by about 25%. Our study highlights the importance of financial frictions in analyzing climate change impacts.

Suggested Citation

  • Toan Phan & Felipe Schwartzman, 2023. "Climate Defaults and Financial Adaptation," Working Paper 23-06, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:95916
    DOI: 10.21144/wp23-06
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    More about this item

    Keywords

    climate change; disasters; sovereign default; emerging markets; growth;
    All these keywords.

    JEL classification:

    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods

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