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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
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    File URL: https://www.bancaditalia.it/pubblicazioni/mercati-infrastrutture-e-sistemi-di-pagamento/approfondimenti/2025-062/N.62-MISP.pdf
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    More about this item

    Keywords

    Climate Change; Credit Risk; EDF; Carbon Emissions; Transition Risk;
    All these 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

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