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Carbon default swap – disentangling the exposure to carbon risk through CDS

Author

Listed:
  • Blasberg, Alexander
  • Kiesel, Rüdiger
  • Taschini, Luca

Abstract

Using Credit Default Swap spreads, we construct and validate a forward-looking, market-implied carbon risk (CR) factor and show that the impact of carbon regulations on firms’ credit risk varies with the regulation’s scope and stringency, and with the speed of mandated carbon reduction. We find that explicit carbon pricing sharpens lenders’ evaluations, resulting in firms under such regimes incurring three times the additional credit protection costs. This impact escalates with the proportion of a firm’s direct emissions subject to regulation – the policy’s stringency – and varies by the sector in which the firm operates. With an increase in the CR factor, lenders foresee higher costs for short-term transitions.

Suggested Citation

  • Blasberg, Alexander & Kiesel, Rüdiger & Taschini, Luca, 2024. "Carbon default swap – disentangling the exposure to carbon risk through CDS," LSE Research Online Documents on Economics 128528, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:128528
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    File URL: http://eprints.lse.ac.uk/128528/
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    More about this item

    Keywords

    carbon risk; climate change; climate finance; credit risk; transition risk;
    All these keywords.

    JEL classification:

    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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