IDEAS home Printed from https://ideas.repec.org/p/bdi/wpmisp/mip_062_25.html
   My bibliography  Save this paper

The Rise of Climate Risks: Evidence from Firms' Expected Default Frequencies

Author

Listed:
  • Matilde Faralli

    (Imperial College London)

  • Francesco Ruggiero

    (Bank of Italy, Financial Risk Management Directorate)

Abstract

We investigate the relationship between climate transition risk and credit risk by analyzing firms’ carbon emissions and Moody’s Expected Default Frequencies (EDFs). We find evidence of a structural shift following the Paris Agreement, whereby absolute emissions have become significantly associated with higher EDFs. By decomposing EDFs into their core components, we identify increased asset volatility as the main channel through which transition risk affects credit risk for large emitters. Our analysis illuminates the mechanisms linking climate transition risk to financial risk. The results are robust to various model specifications, control variables, and winsorization thresholds, and suggest that climate-related financial risks are becoming increasingly relevant for credit markets.

Suggested Citation

  • Matilde Faralli & Francesco Ruggiero, 2025. "The Rise of Climate Risks: Evidence from Firms' Expected Default Frequencies," Mercati, infrastrutture, sistemi di pagamento (Markets, Infrastructures, Payment Systems) 62, Bank of Italy, Directorate General for Markets and Payment System.
    • Handle: RePEc:bdi:wpmisp:mip_062_25
    as

    Download full text from publisher

    File URL: https://www.bancaditalia.it/pubblicazioni/mercati-infrastrutture-e-sistemi-di-pagamento/approfondimenti/2025-062/N.62-MISP.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Patrycja Klusak & Matthew Agarwala & Matt Burke & Moritz Kraemer & Kamiar Mohaddes, 2023. "Rising Temperatures, Falling Ratings: The Effect of Climate Change on Sovereign Creditworthiness," Management Science, INFORMS, vol. 69(12), pages 7468-7491, December.
    2. Zacharias Sautner & Laurence Van Lent & Grigory Vilkov & Ruishen Zhang, 2023. "Firm‐Level Climate Change Exposure," Journal of Finance, American Finance Association, vol. 78(3), pages 1449-1498, June.
    3. Monasterolo, Irene & de Angelis, Luca, 2020. "Blind to carbon risk? An analysis of stock market reaction to the Paris Agreement," Ecological Economics, Elsevier, vol. 170(C).
    4. Yujing Gong & Kung-Cheng Ho, 2021. "Corporate social responsibility and managerial short-termism," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 28(5), pages 604-630, September.
    5. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    6. Stellner, Christoph & Klein, Christian & Zwergel, Bernhard, 2015. "Corporate social responsibility and Eurozone corporate bonds: The moderating role of country sustainability," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 538-549.
    7. Benjamin Yibin Zhang & Hao Zhou & Haibin Zhu, 2009. "Explaining Credit Default Swap Spreads with the Equity Volatility and Jump Risks of Individual Firms," The Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5099-5131, December.
    8. Gao, Feng & Li, Yubin & Wang, Xinjie & Zhong, Zhaodong (Ken), 2021. "Corporate social responsibility and the term structure of CDS spreads," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 74(C).
    9. Bolton, Patrick & Kacperczyk, Marcin, 2021. "Do investors care about carbon risk?," Journal of Financial Economics, Elsevier, vol. 142(2), pages 517-549.
    10. Viral V. Acharya & Timothy Johnson & Suresh Sundaresan & Tuomas Tomunen, 2022. "Is Physical Climate Risk Priced? Evidence from Regional Variation in Exposure to Heat Stress," NBER Working Papers 30445, National Bureau of Economic Research, Inc.
    11. Florian Berg & Julian F Kölbel & Roberto Rigobon, 2022. "Aggregate Confusion: The Divergence of ESG Ratings [Corporate social responsibility and firm risk: theory and empirical evidence]," Review of Finance, European Finance Association, vol. 26(6), pages 1315-1344.
    12. Diego R. Känzig, 2023. "The Unequal Economic Consequences of Carbon Pricing," NBER Working Papers 31221, National Bureau of Economic Research, Inc.
    13. Florian Barth & Benjamin Hübel & Hendrik Scholz, 2022. "ESG and corporate credit spreads," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 23(2), pages 169-190, February.
    14. Alain Devalle & Simona Fiandrino & Valter Cantino, 2017. "The Linkage between ESG Performance and Credit Ratings: A Firm-Level Perspective Analysis," International Journal of Business and Management, Canadian Center of Science and Education, vol. 12(9), pages 1-53, August.
    15. 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.
    16. Lee H. Seltzer & Laura Starks & Qifei Zhu, 2022. "Climate Regulatory Risk and Corporate Bonds," NBER Working Papers 29994, National Bureau of Economic Research, Inc.
    17. André Höck & Christian Klein & Alexander Landau & Bernhard Zwergel, 2020. "The effect of environmental sustainability on credit risk," Journal of Asset Management, Palgrave Macmillan, vol. 21(2), pages 85-93, March.
    18. Kabir, Md Nurul & Rahman, Sohanur & Rahman, Md Arifur & Anwar, Mumtaheena, 2021. "Carbon emissions and default risk: International evidence from firm-level data," Economic Modelling, Elsevier, vol. 103(C).
    19. Witold J. Henisz & James McGlinch, 2019. "ESG, Material Credit Events, and Credit Risk," Journal of Applied Corporate Finance, Morgan Stanley, vol. 31(2), pages 105-117, June.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Costola, Michele & Vozian, Katia, 2025. "Pricing climate transition risk: Evidence from European corporate CDS," Energy Economics, Elsevier, vol. 143(C).
    2. Meles, Antonio & Salerno, Dario & Sampagnaro, Gabriele & Verdoliva, Vincenzo & Zhang, Jianing, 2023. "The influence of green innovation on default risk: Evidence from Europe," International Review of Economics & Finance, Elsevier, vol. 84(C), pages 692-710.
    3. Ugolini, Andrea & Reboredo, Juan C. & Ojea-Ferreiro, Javier, 2024. "Is climate transition risk priced into corporate credit risk? Evidence from credit default swaps," Research in International Business and Finance, Elsevier, vol. 70(PB).
    4. Rahman, Sohanur, 2024. "The importance of green patents for CDS pricing: The role of environmental disclosures," Energy Economics, Elsevier, vol. 139(C).
    5. Blasberg, Alexander & Kiesel, Rüdiger & Taschini, Luca, 2023. "Carbon default swap – disentangling the exposure to carbon risk through CDS," LSE Research Online Documents on Economics 118092, London School of Economics and Political Science, LSE Library.
    6. Helena Redondo & Elisa Aracil, 2024. "Climate‐related credit risk: Rethinking the credit risk framework," Global Policy, London School of Economics and Political Science, vol. 15(S1), pages 21-33, March.
    7. Okimoto, Tatsuyoshi & Takaoka, Sumiko, 2024. "Credit default swaps and corporate carbon emissions in Japan," Energy Economics, Elsevier, vol. 133(C).
    8. Fabrizio Ferriani & Marcello Pericoli, 2024. "ESG risks and corporate viability: insights from default probability term structure analysis," Questioni di Economia e Finanza (Occasional Papers) 892, Bank of Italy, Economic Research and International Relations Area.
    9. Ballester, Laura & González-Urteaga, Ana & Martínez, Beatriz, 2025. "When is environmental performance most valued? International evidence from the CDS market," International Review of Economics & Finance, Elsevier, vol. 99(C).
    10. Alessi, Lucia & Ossola, Elisa & Panzica, Roberto, 2023. "When do investors go green? Evidence from a time-varying asset-pricing model," International Review of Financial Analysis, Elsevier, vol. 90(C).
    11. Fliegel, Philip, 2025. "“Brown” Risk or “Green” Opportunity? The dynamic pricing of climate transition risk on global financial markets," Energy Economics, Elsevier, vol. 145(C).
    12. Benkraiem, Ramzi & Dimic, Nebojsa & Piljak, Vanja & Swinkels, Laurens & Vulanovic, Milos, 2025. "Media-based climate risks and international corporate bond market," Journal of International Money and Finance, Elsevier, vol. 151(C).
    13. He, Feng & Ren, Xingzi & Wang, Yueren & Lei, Xingfan, 2025. "Climate risk and corporate bond credit spreads," Journal of International Money and Finance, Elsevier, vol. 154(C).
    14. Dallocchio, Maurizio & D’Ercole, Francesco & Frascati, Domenico & Mariani, Massimo, 2025. "Climate transition and the speed of leverage adjustment," International Review of Financial Analysis, Elsevier, vol. 102(C).
    15. Nguyen, Harvey & Pham, Anh Viet & Pham, Man Duy (Marty) & Pham, Mia Hang, 2025. "Climate change and corporate credit worthiness: International evidence," Global Finance Journal, Elsevier, vol. 64(C).
    16. Giulia Livieri & Davide Radi & Elia Smaniotto, 2023. "Pricing Transition Risk with a Jump-Diffusion Credit Risk Model: Evidences from the CDS market," Papers 2303.12483, arXiv.org.
    17. Alessi, Lucia & Duranovic, Anja & Kvedaras, Virmantas & Monasterolo, Irene, 2025. "From risks to opportunities: The impact of green public investment programs on sovereign yields," Research in International Business and Finance, Elsevier, vol. 77(PA).
    18. Alexander Blasberg & Rüdiger Kiesel & Luca Taschini, 2022. "Carbon Default Swap - Disentangling the Exposure to Carbon Risk through CDS," CESifo Working Paper Series 10016, CESifo.
    19. Ballester, Laura & González-Urteaga, Ana & Shen, Long, 2024. "Green bond issuance and credit risk: International evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 94(C).
    20. Ferriani, Fabrizio, 2023. "Issuing bonds during the Covid-19 pandemic: Was there an ESG premium?," International Review of Financial Analysis, Elsevier, vol. 88(C).

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bdi:wpmisp:mip_062_25. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/bdigvit.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.