Research in International Business and Finance 62 (2022) 101685

Contents lists available at ScienceDirect

Research in International Business and Finance

journal homepage: www.elsevier.com/locate/ribaf

Climate change and the pricing of sovereign debt: Insights from

European markets
Iustina Alina Boitan a, *, Kamilla Marchewka-Bartkowiak b
a
Bucharest University of Economic Studies, Faculty of Finance and Banking, Strada Mihail Moxa 5–7, sector 1, 010961 Bucharest, Romania
b
Poznań University of Economics and Business, Institute of Finance, al. Niepodleglosci 10, 61–875 Poznań, Poland

A R T I C L E I N F O A B S T R A C T

JEL classifications: The paper analyses the impact of several climate change metrics (performance, exposure to
C33 extreme events, vulnerability, readiness, climate debt) on the cost of government borrowing
E30 expressed as both sovereign bond yields and sovereign risk premium, in a panel of European
H63
Union countries over 2000–2020. Findings show that climate-vulnerable countries, exhibiting
Q54
low climate disaster managerial abilities in mitigating the climate challenges pay a higher risk
Keywords:
premium on their sovereign debt. Euro-area countries record lower sovereign bond yields and
Climate change
spreads than non-members, while south-eastern European countries face higher sovereign yields
Sovereign debt market
Sovereign borrowing cost and spreads. The classification of countries into different bio-geographic regions, according to
Sovereign risk observed and projected climate change patterns, shows that Atlantic-region countries experience
both lower sovereign bond yields and spreads while Mediterranean countries face higher yields.
Results emphasise that countries with lower fiscal space, impaired fiscal and economic indicators
have to pay higher yields when issuing sovereign bonds and witness larger spreads.

1. Introduction

The latest report of the Intergovernmental Panel on Climate Change (IPCC, 2021) leaves no illusions that climate change can be
stopped. In reference to the financial impact assessment, it is also clear that the climate change will indirectly act on a sovereign debt
market. As was emphasized in the recent publications of the Center for Sustainable Finance (2021, p. 93), “climate risk should be
integrated in public sector funding and debt management strategies”. The rating agency Standard & Poor’s (2014) also points out that
climate change can be treated as a “global mega-trend for sovereign risk” and it will impact creditworthiness probably through various
channels, including economic growth, external performance, and public finance. Sovereign debt managers should respond to the
increasing market investor sensitivity to the problem of the financial consequences of climate change. It is also the result of the
introduced regulatory changes regarding environmental risk such as Environment-Social-Governance reporting (ESG, 2020) and the
Sustainable Finance Disclosure Regulation SFDR, 2019).
Sovereign debt managers, whose major objective is to cover the borrowing requirements of public authorities, taking into account
cost minimization and prudent management of risks associated with incurring debt (World Bank and IMF, 2002), will be forced to
answer this new challenge in two approaches. The first approach is to consider climate policy in new debt instruments, such as
sovereign green bonds and bills, but also new tasks such as a public carbon funds management or EU-ETS auction settlement and new
investor relations analysis and reports (Marchewka-Bartkowiak, 2021). The second approach is the inclusion of climate change as a

* Corresponding author.
E-mail addresses: iustina.boitan@fin.ase.ro (I.A. Boitan), kamilla.marchewka-bartkowiak@ue.poznan.pl (K. Marchewka-Bartkowiak).

https://doi.org/10.1016/j.ribaf.2022.101685
Received 5 December 2021; Received in revised form 6 May 2022; Accepted 24 May 2022
Available online 31 May 2022
0275-5319/© 2022 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY license
(http://creativecommons.org/licenses/by/4.0/).
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

permanent component of debt service cost and risk assessment. These two approaches should be treated jointly.
Our paper refers to the second approach and subscribes to a newly emerged strand of literature related to the empirical assessment
of the interplay between climate change and sovereign debt cost. More specifically, the paper contributes to the literature by analyzing
the impact of several climate change metrics (in terms of performance, exposure to extreme events, vulnerability, and readiness) on the
cost of government borrowing (the sovereign cost of capital) in a panel of European Union (EU) countries over the period 2000–2020.
The main research objective is to investigate whether climate change proxies exert a significant impact on sovereign bond yields
and on the sovereign risk premium. A second related research objective is to comprehensively reveal the type of challenge/distress
event that determines most the sovereign cost of borrowing: climate change (by using 5 climate metrics), the distress on the financial
market, the distress on the sovereign debt market, or the uncertainty arising from a multitude of economic, political, and health crises.
To the best of our knowledge, only four recent papers have studied so far this ongoing climate challenge (Kling et al., 2018; Cevik
and Jalles, 2020; Volz et al., 2020; Beirne et al., 2021a), and their samples comprise a heterogeneous geographical coverage of
countries with particular focus on African and Southeastern Asian countries. Their choice is motivated by the need of paying increased
attention on those countries most heavily affected by climate change, whose devastating impacts on the economy increasing at a faster
pace than in other world regions. The climate change proxies used by all existing studies are represented by the climate vulnerability
and resilience indices, as measured by the ND-GAIN index. Currently, the data coverage for these indices is limited till 2018, which
consists of a major drawback for updated analyses.
The novelty of our paper involves addressing the deficit of studies on this topical issue and generating new research findings, with a
particular emphasis on EU countries. Our choice substantiates the fundamental scope and ambition underlying the creation of the
European Union, namely the achievement of the deepest political, institutional, economic, and legal integration across individual
countries. Consequently, as the European Union has emerged as a coherent, integrated, and shared decision-making structure, we
expect it to better reveal the impact of some global-interest variables, such as the climate-related ones.
Another issue of novelty is the use of a new, recent dataset for a time coverage spanning over two decades. More in details, we
employ two new untested metrics for measuring climate change (developed by the GermanWatch institute), and we compute a new
indicator named ‘climate liability’ to measure the annual financial cost of national carbon emission commitments. To integrate our
new findings in the existing stream of literature, we consider also the two climate vulnerability and readiness ND-GAIN indices that
have been considered so far in the existing literature. Consequently, using an augmented set of five climate change proxies allows us to
capture in a comprehensive and nuanced manner the impact exerted on a country’s cost of borrowing (measured alternatively in terms
of yield and spread).
Another novel feature is represented using a series of country-dummies to control for EU countries’ membership to the euro-zone,
for the geographical affiliation (Eastern and Southern Europe versus Northern and Western Europe), and respectively for the bio-
geographical classification according to their climate change patterns.
Finally, we employ three alternative distress indicators to account for the financial stress on the sovereign debt market, on the
financial markets and for global uncertainty. No previous study has employed this range of indicators in relationship with sovereign
bond yields and spread.
The remaining structure of the paper is as follows: the second section summarizes previous research on the topic of our paper; the
third describes the specific dataset employed and methodological details; the fourth presents and discusses the results obtained for the
baseline models, the various robustness checks performed and the size effect belonging to each individual leading variable. The last
part concludes.

2. Literature review

Recently, a new field of literature and discussion has developed to empirically assess whether there is a relationship between
climate change and various proxies of the financial stability, including sovereign debt sustainability (Carney, 2015; Zenios, 2021;
ECB/ESRB, 2021).
Some papers follow a broader approach on the environmental challenges by considering Environmental, Social, and Governance
(ESG) indices in connection with the sovereign borrowing cost, expressed in terms of sovereign bond spreads, while others adopt a
more focused approach by employing climate change metrics. Crifo et al. (2017) investigate the impact of government ESG perfor­
mance on public debt by using sovereign bond spreads for selected OECD countries and outline that higher ESG ratings are associated
with lower government borrowing costs.
The negative correlation between countries’ socially responsible performances and the sovereign bonds spread is explained as a
reward provided by investors for countries displaying higher ESG indicators. This finding is validated by Capelle-Blancard et al. (2019)
who employ a different ESG performance metric and show that countries with good ESG performance are significantly associated with
lower default risk and lower sovereign bond yield spreads. Therefore, by incorporating ESG metrics into sovereign risk analyses a
discernible financial effect of sustainability-related information on sovereign spreads is noticed. The explanation resides in ESG acting
as a flag of a country’s commitment to long-term sustainability, which creates a buffer against negative shocks. The conclusions of this
paper may also be related to another strand of literature that investigates the informational efficiency of the bond markets. This
situation corresponds to a market where prices fully reflect all available information (Fama, 1976), the security prices adjust to new
information very rapidly (Kumar, 2016), and therefore the main issue is to determine the information set against which prices should
be tested (Zunino et al. 2012).
There are also research particularly focused on green bond market and its relationship to CO2 emission (Ehlers et al., 2020; Fatica
and Panzica, 2020). In this context it is worth noting that sovereign green bonds are considered by the central banks as acting as a

2
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

“green asset” in a future open market and foreign reserve management (ECB, 2021; Fender et al. 2019).
According to Volz et al. (2020) there is also a growing body of research dedicated to examining the macroeconomic impacts of
climate change, but very scarce systematic analysis performed to date on the interplay between climate change and sovereign risk,
despite the potentially profound implications for policymakers. The authors focus on six major fields such as fiscal impacts of
climate-related natural disasters, fiscal consequences of adaptation and mitigation policies, macroeconomic impacts of climate change,
climate-related risks and financial sector stability, impacts on international trade and capital flows and impacts on political stability.
The potential problem regarding the information and data needed to estimate the climate change influence on sovereign risk is
attempted to be solved by Agarwala et al. (2021), who proposed taxonomy for tracing the physical and transition impacts of climate
change through the impacts on sovereign risk. Additionally, to continue the climate risk assessment, Klusak et al. (2021) proposed the
world’s first climate-adjusted sovereign credit rating and simulated it on 108 countries.
To our knowledge, the first study that analyses particularly the impact of climate change on the sovereign borrowing cost belongs to
Kling et al. (2018) who uncover, that countries particularly vulnerable to climate change are facing a higher risk premium on their
sovereign debt. Cevik and Jalles (2020) also found that the vulnerability and resilience to climate change have a significant impact on
the cost government borrowing, after controlling for conventional determinants of sovereign risk. It means that countries that are more
resilient to climate change have lower bond yields and spreads relative to countries with greater vulnerability to risks associated with
climate change. It was also confirmed by Beirne et al. (2021a, b) for Southeast Asia.
Our research examines the European Union member states, because we can agree with one of the conclusions formulated by Zenios
(2021) that coordination by EU institutions to develop regional scenarios will ensure acceptability, raise ambitions in dealing with
climate risks and encourage the fiscal authorities to think of solutions.

Table 1
List of variables.
Variable name (abbreviation) Description Source of data

Dependent variables
Sovereign bond yields (YLD)
Sovereign yield spread (SPR)
Independent variables
Budget balance/GDP
(government deficit or
surplus) (BB)
Government debt/GDP (DBT)
Primary balance (% GDP) (PB)
Sovereign Rating (SR)
GDP growth rate (GDP)
Inflation rate (IR)
Dummy for the euro-zone
membership (D1)
Dummy for the geographical
affiliation (D2)
Dummy for the bio-regional
affiliation (D3, D4, D5, D6)
Climate Change Performance
Index (CCPI)
Climate Risk Index (CRI)
Climate liabilities (CL)
Climate risk vulnerability index
(CRV)
Climate risk readiness index
(CRR)
Distress on the sovereign debt
market (SovCISS index)
Distress on the financial market
(CLIFS index)
Uncertainty from economic,
political, health crises (WUI
index)
Government bond yields, with 10-year maturity Eurostat
10-year government bond yield (differential vs. US sovereign bonds of 10- Eurostat,
year maturity) European Central Bank, (2021)
Net lending (+) /net borrowing (-) as percentage of GDP Eurostat
Government consolidated gross debt as percentage of GDP Eurostat
Fiscal balance net of interest payments on government liabilities, as Eurostat
percentage of GDP
Measures the sovereign credit rating. A downgrade implies higher credit Moody’s Sovereign Rating List
risk.
GDP at market prices, percentage change on previous period Eurostat
Harmonised Indices of Consumer Prices (annual average rate of change) Eurostat
Binary variable, taking value 1 for a country’s membership to euro-area, and Own computation
0 otherwise
Binary variable, taking value 1 for a country’s affiliation to the South- Own computation
Eastern Europe region, and 0 otherwise
Binary variables, taking value 1 for a country’s inclusion in a given bio- Own computation, based on the
regional area (Mediterranean, Continental, Atlantic, Boreal), and classification made by the European
0 otherwise Environment Agency
Measures the climate protection performance at country-level GermanWatch Institute
Indicates a country’s level of exposure and vulnerability to extreme climate
events
New type of financial liability, directly connected with the scale of a Own computation
country’s CO2 gas emissions
Measures a country’s overall vulnerability to the negative effects of climate Notre Dame Global Adaptation Initiative
change (ND-GAIN)
Measures a country’s overall readiness and adaptability to climate change
Country-level index indicating the sovereign systemic stress in European European Central Bank, (2021)
sovereign debt markets
Country-level index of financial stress that covers three financial market European Central Bank, (2021)
segments: equity markets, bond markets and foreign exchange markets
Country-level index computed by counting the frequency of the word Ahir et al. (2018)
uncertainty (or its variants) in the Economist Intelligence Unit country
reports. A higher number means higher uncertainty.

3
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

3. Analytical background

3.1. Data and variables

The data consists of a panel data set that comprises a sample of 26 European Union countries, observed over a period of 21 years
(from 2000 to 2020), with annual frequency. As data for Estonia and the UK were not available for a series of indicators, these countries
have been removed from the subsequent analysis. The complete list of indicators considered for both the initial model validation and
further robustness checks is presented in Table 1.
Most variables have been collected from official statistical databases, while others have been constructed by relying on various
input sources, as described below.
The sovereign credit rating is employed to reflect the government’s ability to meet its financial liabilities. We measure it by the
Moody’s sovereign rating, which has been transformed into a numerical variable, ranging from 1 to 21. By convention, the notation
scale assigns greater scores to those ratings signalling higher risk. For instance, the Aaa symbol corresponds to a value of 1, the Aa1
symbol corresponds to a value of 2, and so on (see Sehgal et al. 2018 for the complete list of the rating scale). When there is more than
one rating assigned during a particular year, we calculate the average numerical value of these ratings. Our approach is in line with
González-Fernández and González-Velasco (2018) who focused also on Moody’s sovereign rating. Another argument for relying on the
sovereign rating provided by Moody’s resides in its characteristic of being the most reliable model among the three main sovereign
ratings, in terms of the accuracy of predictions made (Sehgal et al. 2018). Most studies in this field prefer this metric, while Afonso et al.
(2015) employed sovereign credit ratings published by three main rating agencies - Standard and Poor’s, Moody’s and Fitch, and the
papers of Crifo et al. (2017), Capelle-Blancard et al. (2019) used only the S&P rating.
Climate liabilities represent a new indicator we compute for the purpose of this study, as a proxy for the financial burden to be
borne by the government. This potential liability emerges from the amount of pollution generated through CO2 emissions. We rely on
the Report of the High-Level Commission on Carbon Prices (2017) that estimates a carbon-price level of US$ 40–80/tCO2 by 2020 and
US$ 50–100/tCO2 by 2030 for each tonne of carbon emissions generated by a given country, and use a discounted carbon cost
framework to estimate the carbon cost per year. Specifically, in the 10 years between 2020 and 2030, the lower end of the carbon cost
increases by 10US$, thus it is an increase of 1US$/year. We further use this annual cost in a discounted manner, to compute the climate
liabilities for each year during 2000–2020. For instance, in 2019 the carbon cost is of 39US$, in 2018 of 38US$ while in 2000 it is a cost
of 20US$ per tonne of carbon. Once the carbon cost per year is estimated in a backward manner, we multiply it with the CO2 gas
emissions generated each year by every country in our sample. Our approach is similar to Mitchell et al. (2021), who rely on the same
authoritative High-Level Commission report regarding the estimates of carbon costs and allow the cost to fall for historic emissions, in
a discounted manner.
The dummy variable related to the geographical affiliation of EU countries delineates between two main geographical regions. The
Eastern and Southern Europe region includes economies in Eastern Europe (Bulgaria, Croatia, the Czech Republic, Hungary, Poland,
Romania, the Slovak Republic, and Slovenia) and Southern Europe (Cyprus, Greece, Italy, Malta, Portugal, and Spain). The Northern
and Western Europe region includes economies from Northern Europe (Denmark, Finland, Ireland, Latvia, Lithuania, and Sweden),
and Western Europe (Austria, Belgium, France, Germany, the Netherlands). For this classification we relied on the European Com­
mission’s (2008) report which documents that the pressures from climate change are not evenly distributed across European countries
and some particular regions seem to be increasingly exposed to this asymmetric impact. More specifically, geographical regions subject
to the highest climate change pressure are generally located in the South and East of Europe, while more limited pressures are expected
in Northern and Western Europe. Consequently, this dummy allows us to study the core-periphery pattern exhibited by European
countries to the challenges imposed on by the manifestation of climate change vulnerabilities.
For the bio-geographical affiliation of an EU country we constructed four novel dummy variables, taking value 1 for a country’s
membership to a given bio-region and 0 otherwise. We had as a starting point the classification of EU countries into a series of bio-
geographic regions, according to the observed and projected climate change patterns, updated by the European Environment
Agency in August 2020. For instance, the Mediterranean region dummy takes value 1 for Croatia, Cyprus, Greece, Italy, Malta,
Portugal, and Spain. The Continental region dummy takes value 1 for Austria, Bulgaria, the Czech Republic, Denmark, France, Ger­
many, Hungary, Luxembourg, Poland, Romania, Slovakia, and Slovenia. The Atlantic region dummy takes value 1 for Belgium, France,
Ireland, and the Netherlands. The Boreal region dummy takes value 1 for Finland, Latvia, Lithuania, and Sweden.
The third dummy, represented by the euro-area membership of a country, signals its belonging to the European Monetary Union, an
alliance of countries that have met a series of strict prerequisites regarding their macroeconomic fundamentals. The admission criteria
the euro-zone countries have complied with are related to the price and exchange rate stability, stable long-term interest rates and
sound and sustainable public finances (measured in terms of government deficit and debt). Therefore, this dummy delineates between
euro-area countries and those that still do not meet these convergence criteria, to account for the specific pattern of the sovereign
borrowing cost on the background of environmental concerns and challenges.
Drawing on the mainstream economic literature that investigated the determinants of sovereign bond yields and risk premium, we
decided for the most appropriate set of macroeconomic and fiscal controls to be included in our study.
GDP growth rate is widely used by a number of previous studies as a proxy for the business cycle, to control for the size of the
economy (González-Fernández and González-Velasco, 2018) and to measure a country’s economic strength (Sehgal et al., 2018) and
wealth (Capelle-Blancard et al., 2019), in a general belief that a country entered on a path of economic growth is more able to fulfil its
financial obligations than stagnating economies (Crifo et al., 2017).
A high inflation rate is a sign of structural problems with government’s finances and its ability to pay for current budgetary

4
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

expenses, thus it is expected a positive relationship between the inflation rate and sovereign bonds yield and spread (Crifo et al., 2017).
In addition, an environment of higher inflation increases the overall uncertainty in economic prospects and also implicitly impacts the
yield of long-term bonds, by increasing their level and widening the spread (González-Fernández and González-Velasco, 2018).
To control for the overall health and strength of a government’s finances (Sehgal et al. 2018), we employ several fiscal position
variables. The public debt-to-GDP ratio is a control variable that captures the fiscal determinants of the sovereign risk (Bruha and
Kocenda, 2018) and signals escalating public financing needs (Bouis, 2019). According to Schuknecht et al. (2009), higher levels of
sovereign debt are expected to increase the default risk and, as a consequence, the yield spreads. Economic literature expects a positive
statistical relation between public debt/GDP and the spread: a larger size of the public debt should cause a subsequent increase in
spreads (Afonso et al., 2015; Capelle-Blancard et al., 2019).
The budget balance-to-GDP ratio and the primary balance ratio indicates the efficient utilization of public finances and may affect a
country’s creditworthiness (Sehgal et al. 2018), because governments running larger fiscal deficits are perceived as less creditworthy
and this spillover effect further amplifies the default risk (Attinasi et al., 2009). The deterioration of fiscal position indicators translates
into an increase of sovereign bond yields (Gruber and Kamin, 2012), while lower values for the budget balance increases spreads
(Afonso et al., 2015; Crifo et al., 2017).
Following Afonso et al. (2015), Crifo et al. (2017) and González-Fernández and González-Velasco (2018), it is expected an inverse
statistical relation between the sovereign credit rating and the sovereign risk proxies, as any worsening of the rating should be
perceived by market participants as synonymous with higher sovereign borrowing costs and risk premium. Afonso et al. (2015) further
explain that, in a fully efficient market, sovereign credit ratings and outlook announcements should not impact bonds’ prices, and
consequently their estimated coefficients should equal zero. But if markets are efficient only in the semi-strong form, then the esti­
mated coefficient of the sovereign credit rating variable is statistically significant and different from zero, suggesting that market
participants pay attention at its changes and treat it as revealing new information, which was previously available only for credit rating
agencies.
The choice for employing a broad array of dummy variables substantiates in the more granular picture they bring regarding the
specific influence exerted on the dependent variables by various subpanels of countries, depending on their institutional membership,
geographical and bio-geographical affiliation. For instance, the Continental region dummy divides the initial sample of EU countries in
two subpanels, based on their bio-geographic characteristics. Another reason for the use of these dummy variables has its roots in the
report published by the Bank for International Settlements (2021), explaining that “geographical heterogeneity is driven by several
factors: differences in the likelihood and severity of climate risk drivers themselves; structural differences in economies and markets
that affect the relative importance of various transmission channels; and differences in financial systems that may impact banks’
exposures to climate-related risks”.
Regarding the climate change metrics, our study is the first to employ the two indices developed and computed annually by
GermanWatch Institute, their main advantage being more recent time coverage and the complementary information they bring
compared to existing indices.
The Climate Change Performance Index (CCPI) represents a monitoring tool for measuring a country’s efforts to mitigate climate
change and for tracking its climate protection performance. Its stated aim is to evaluate countries’ progress in implementing public
policies that converge towards achieving the Paris Agreement on limiting global warming goals. By enabling cross-country compar­
isons and rankings in terms of climate protection efforts and progress, it positions itself as a reliable tool for identifying leaders and
laggards in climate protection, and in holding governments accountable for their responsibility of combating the climate crisis (Burck
et al., 2020). The index evaluates a country’s performance in four categories: Greenhouse Gas Emissions (40 % of the overall ranking),
Renewable Energy (20 %), Energy Use (20 %) and Climate Policy (20 %). The higher the score of the index, the better placed a country
is in terms of climate protection policy performance.
The Climate Risk Index (CRI) evaluates to what extent countries have been affected by impacts of weather-related loss events
(storms, floods, heat waves, etc.), in terms of increased fatality rates and direct economic losses. The lower the CRI score, the higher a
country’s level of exposure and vulnerability to extreme events (Eckstein et al., 2021). The index level should be understood by
governments as a warning signal and an awareness raising opportunity for designing and implementing effective climate change
policies, to prevent potential vulnerability and damage from extreme weather events.
Finally, the climate liability variable reflects the carbon cost to be supported by each country, depending on its levels of CO2
emissions. Although no previous study has investigated the effect of these climate-related variables on sovereign yields or spread, in
order to document on the expected signs of the estimated coefficients we can rely on the papers of Volz et al. (2020), Cevik and Jalles
(2020) and Beirne et al. (2021a,b) who found that vulnerability to climate risk is positively related to sovereign bond yields and
spreads. In our case, vulnerability to climate risk translates as potentially higher carbon costs due to a country’s larger amounts of CO2
emissions.
Additionally, for conducting the robustness checks we consider a complementary set of explanatory variables meant to measure
climate risk vulnerability and readiness, as well as various types of country-level distress events, namely: distress on the financial
market (with CLIFS index), distress on the sovereign debt market (SovCISS index), and the uncertainty arising from a multitude of
economic, political, and health crises (World Uncertainty Index - WUI).
The climate vulnerability index measures a country’s exposure to significant climate change from a biophysical perspective, its
sensitivity and capacity to adapt to the negative effects of climate change that affect six life-supporting sectors: food, water, health,
services, human habitat, and infrastructure. The climate readiness index measures a country’s overall readiness by focusing on three
components, namely economic, governance, and social readiness which determine the mobilization of investments capabilities to­
wards climate adaptation actions that could further diminish climate vulnerability (see Chen et al., 2015 for detailed methodological

5
 I.A. Boitan and K. Marchewka-Bartkowiak
Table 2
Correlation matrix.
BB DBT PB SR GDP IR D1 D2 D3 D4 D5 D6 CCPI CRI CL CRV CRR SovCISS CLIFS WUI

BB 1 -0,50 0,96 -0,42 0,43 -0,04 -0,19 -0,39 -0,36 0,07 -0,07 0,34 -0,04 0,14 -0,10 -0,34 0,48 -0,35 -0,41 0,11
DBT 1 -0,65 0,54 -0,37 -0,13 0,59 0,24 0,55 -0,29 0,14 -0,37 0,15 -0,23 0,27 0,36 -0,44 0,19 0,12 -0,09
PB 1 -0,52 0,44 -0,06 -0,26 -0,45 -0,46 0,13 -0,06 0,41 -0,03 0,20 -0,12 -0,43 0,56 -0,38 -0,39 0,14
SR 1 -0,03 -0,10 -0,09 0,74 0,46 -0,10 -0,16 -0,36 -0,01 -0,14 0,02 0,45 -0,81 0,13 0,07 -0,06
GDP 1 -0,01 -0,27 -0,03 -0,28 0,17 0,01 0,05 -0,29 -0,01 -0,03 -0,09 0,03 -0,49 -0,48 0,08
IR 1 -0,08 0,12 -0,01 0,10 -0,09 -0,06 -0,27 -0,05 0,02 0,09 -0,08 0,15 0,18 0,02
D1 1 -0,22 0,39 -0,49 0,39 -0,15 -0,10 -0,14 0,32 -0,02 0,01 0,10 0,06 -0,05
D2 1 0,65 -0,02 -0,51 -0,33 -0,24 -0,22 0,20 0,31 -0,86 0,13 0,05 0,04
D3 1 -0,51 -0,33 -0,22 -0,11 -0,21 0,21 0,21 -0,57 0,29 0,08 0,03
6

D4 1 -0,22 -0,33 0,01 -0,22 0,16 -0,21 0,08 -0,17 -0,06 -0,07
D5 1 -0,22 0,05 0,09 0,06 0,33 0,14 -0,07 -0,01 -0,32
D6 1 0,19 0,36 -0,36 -0,48 0,51 -0,09 0,00 0,31
CCPI 1 0,13 -0,14 -0,08 0,26 0,26 0,21 -0,08
CRI 1 -0,40 0,12 0,25 0,01 0,06 -0,01
CL 1 -0,15 -0,30 -0,13 -0,10 0,13
CRV 1 -0,45 0,11 0,02 -0,28

Research in International Business and Finance 62 (2022) 101685

CRR 1 -0,09 -0,07 0,04
SovCISS 1 0,68 -0,05
CLIFS 1 -0,02
WUI 1

Note: Spearman correlation coefficients based on the pooled sample

I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

aspects). The interpretation of these indices is straightforward: a higher vulnerability score indicates a worse situation, while a higher
readiness score means a better case, a good performance. The SovCISS and CLIFS indices measure distress on particular financial
markets, while the WUI index is developed to comprise manifold sources of uncertainty, such as: economic policy uncertainty, stock
market volatility, financial and debt crises, risk, health crises (SARS and COVID-19) and lower GDP growth, and tends to rise close to
political elections (Ahir et al., 2020).
To the best of our knowledge, these distress indicators have not been so far examined in relationship with the sovereign bond yield
or spread. A singular study in this respect is the one of Volz et al. (2020) that employs a crisis variable represented by the indicator
developed by Laeven and Valencia (2018) to account for the incidence of a crisis event for each country in their sample. Their findings
reveal a positive relationship between the crisis variable and sovereign bond yields. We expect to obtain the same positive link between
our distress variables and the dependent ones, in line with the intuition that the occurrence of adverse events causes an increase of the
risk premium and of the government’s borrowing cost.

3.2. Statistical properties of the data

The initial set of independent variables has been tested for multicollinearity with the Spearman correlation method (Table 2).
Correlation coefficients are low enough to ensure that the estimates will not be biased by high multicollinearity between inde­
pendent variables. The correlation ranges between 0.08 and 0.45 among the five climate change-related variables, suggesting that they
are complementary metrics of a country’s exposure to climate challenges and their informational content is not redundant. Thus, as
they do not fully cover the same aspects, they provide a comprehensive assessment from various standpoints and bring value to our
analytical approach.
We found high correlation of 0.96 between the fiscal balance-to-GDP and the primary balance-to-GDP, so the latter variable will be
used interchangeably with the fiscal budget in the section related to the robustness check. All remaining coefficients show a weak to
moderate intensity of the relationship between any two independent variables, so they will be kept for the further panel analysis.
The basic statistical properties of the variables, expressed in terms of the mean, standard deviation, minimum, maximum, and
median value of the dependent variable as well as the explanatory variables, are summarised in Appendix 1. On average, the overall
sample’s mean value is of 3.52 for the sovereign yield and of 0.23 for the spread. When accounting for the maximum level recorded by
both variables, it appears that Greece leads the ranking, the maximum yield and spread values being recorded in 2012. Greece is also
witnessing the highest values for the government debt in GDP, for all the years considered, compared with the remaining countries in
the sample. In terms of the various climate change indices, financial stress and global uncertainty indices, CCPI and CRI exhibit the
highest mean values, meanwhile all other indices show a subunit mean value. The largest CCPI value was recorded by Denmark in
2014, while the maximum value for CRI was obtained by Finland in 2009. The minimum value in the entire sample was recorded by
Bulgaria in 2014 for CRI and by Greece in 2006 for CCPI.
Additional information on how dispersed the raw values of a given variable around its mean is provided by standard deviation.
When comparing the various climate change indices, the highest spread around the mean and hence the highest heterogeneity of data
is obtained for CRI (25.83), followed by CCPI (19.77) meanwhile the other indices exhibit a close-to-zero standard deviation.
Therefore, the variability of the indices values is broader for the climate metrics illustrating climate performance and climate risk
exposure. The lowest deviation from the mean is recorded for the climate vulnerability and readiness indices, signalling that their
historical values did not experience sharp shifts. It is also the case for the systemic risk, financial stress and uncertainty indices, all of
them exhibiting the same low variability for the time period considered.

3.3. Methodological details

To empirically validate the relationship between the cost of sovereign borrowing faced by EU countries and the evolving climate
risks, we employ a panel model approach. The estimates enable us to assess the effect of several climate-related proxies accounting for
climate performance, risk, vulnerability, readiness, and costs on sovereign bond yields and spread, by controlling for a broad set of
country-specific macroeconomic and fiscal indicators and several dummy variables.
The baseline specification follows the structure:

Yi,t = βXi,t-1 + γCi,t-1 + Dummyi,t + εi,t

where i = 1 to N (the total number of countries in our sample), t = 1 to T (the number of years considered), Y represents the dependent
variable, X represents the set of domestic macroeconomic fundamentals, C stands for the set of climate change proxies, the Dummy
variable represents the various institutional, geographical, and bio-geographical characteristics of a country while ε is the error term.
We rely on two alternative dependent variables, as a measure of the sovereign borrowing cost: (i) the sovereign bond yield with 10-
year maturity, for each country in the sample; and (ii) the sovereign bond yield spread, computed as the difference between the yield of a
specific EU country versus a US Treasury-bond of the same 10-year maturity. The latter represents a benchmark bond also known as the
risk-free rate, because the US government was never at risk of default, even in times of severe economic turmoil (Hilscher and Nos­
busch, 2010; Crifo et al., 2017; González-Fernández and González-Velasco, 2018; Capelle-Blancard et al., 2019). Economic literature
employs the sovereign spreads as a measure of the risk premium over a benchmark bond with similar characteristics, but also for
reflecting sovereign default risk (González-Fernández and González-Velasco, 2018; CFA 2021). A high value of both sovereign yields
and spread is generally an indicative of greater sovereign risk (González-Fernández and González-Velasco, 2018).

7
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

The set of explanatory variables comprises: (i) a series of control variables of macroeconomic and fiscal nature, as well as a set of
dummy variables to depict the institutional, geographical, and bio-geographical affiliation of a country; (ii) several proxy variables to
comprehensively account for issues related to climate risks and challenges.
To test for the presence of the unit root, we applied a series of tests specific to panel data, such as the Levin, Lin & Chu test, the Im,
Pesaran and Shin W-stat and ADF – Fisher Chi-square. Most variables are stationary in level, while the government debt/GDP is
stationary in the first difference. The sovereign bond yields, the spread and climate liabilities are expressed as natural logarithm.
Macroeconomic and fiscal control variables enter the panel regression with lagged value, to reflect that government’s borrowing cost
and risk premium incorporate the information related to the economic cycle and fiscal policies with a time delay.
A common concern in the economic literature is related to addressing the potential sources of endogeneity, the most common being
the problem of omitted variables and the simultaneity between the dependent and independent variables. In this respect, endogeneity
due to omitted variables is mitigated by considering a relevant set of control variables. This approach is in line with Barros et al.
(2020), who explain that employing control variables is a preferential way of avoiding possible endogeneity issues in the empirical
studies conducted for the financial field of research. Regarding the possible simultaneity between the dependent and independent
variables, our choice was to follow standard practice in the empirical literature and estimate a panel model that includes the inde­
pendent variables lagged by one period (Afonso et al., 2015; Capelle-Blancard et al., 2019; Volz et al., 2020; Beirne et al., 2021a,b).
We apply the Panel Least Squares method and test the validity of one of the following baseline models: model without temporal or
cross-section effects, model with fixed effects, respectively a model with random effects. To choose between fixed or random effects for
coefficient estimates we rely on the Likelihood Ratio test and respectively the Hausman test. However, the results generated by the two
tests are inconclusive for the reliable discrimination between the two types of effects; therefore, we considered as a valid model the one
without effects. Thus, we employ a panel Estimated Generalized Least Squares (EGLS) model with cross-section weights to account for
cross-sectional heteroskedasticity and White period method for robust coefficient standard errors.

4. Empirical results: Presentation and discussion

4.1. Determinants of the sovereign bond yields and spread

The first baseline model, having the sovereign bond yields as dependent variable, is run with three climate change proxies and a
specific dummy applied, the set of control variables being always kept unchanged. The results are summarised in Table 3.
The economic and fiscal control variables exhibit high statistical significance, and their estimated signs are largely in line with
theoretical expectations and previous literature. A higher size of sovereign debt in GDP, increased inflation, a worsening fiscal balance
as % of GDP and a sovereign rating downgrade correspond with higher sovereign bond yields. Regarding the fiscal balance/GDP, most
existing studies (Afonso et al., 2015; Crifo et al., 2017) find a negative relation with yields or spreads, while Beirne et al. (2021a) obtain
mixed results for the fiscal balance estimate (both positive and negative signs for various countries), and explain this finding based on
the reasoning that higher fiscal spending per se is not necessarily a problem for the debt sustainability of countries.
In terms of the various dummies used, a country’s status of a euro-area member is negatively related with the sovereign borrowing
cost, meaning that the sovereign bond yields are lower in euro-area members than in non-member countries. Regarding the
geographical dummy, the positive sign of the estimate suggests that South-Eastern Europe countries are facing higher sovereign yields

Table 3
The determinants of sovereign bond yields.
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

gov. deficit/ surplus in -0.06***(0.01) -0.07***(0.01) -0.07***(0.02) -0.06***(0.02) -0.07***(0.02) -0.06***(0.02)

GDP
gov. debt/GDP 0.03***(0.006) 0.02***(0.006) 0.02***(0.007) 0.03***(0.007) 0.02***(0.007) 0.02***(0.007)
Sov. rating 0.05***(0.01) 0.03** (0.01) 0.04***(0.011) 0.06***(0.01) 0.05***(0.01) 0.05***(0.009)
GDP growth rate -0.005 (0.01) -0.004 (0.01) -0.003 (0.01) -0.006 (0.01) -0.002 (0.01) -0.004 (0.01)
inflation rate 0.11***(0.02) 0.13***(0.02) 0.15***(0.02) 0.14***(0.02) 0.13***(0.02) 0.14***(0.02)
Dummy euro-zone -0.3***(0.08)
Dummy SE Europe 0.44***(0.08)
Dummy Mediterranean 0.16*(0.09)
Dummy Continental 0.03
(0.08)
Dummy Atlantic -0.24***(0.09)
Dummy Boreal -0.22***(0.06)
CCPI -0.004** (0.002) -0.003*(0.002) -0.004** (0.002) -0.004***(0.002) -0.004** (0.002) -0.003** (0.002)
Climate Risk Index -0.0001***(1.46e- -8.59E-05*** -0.0001***(1.63E- -0.0001***(1.41E- -9.36E-05*** -0.0001***(1.70e-
05) (1.74E-05) 05) 05) (1.75E-05) 05)
Climate liabilities 0.08***(0.02) 0.03** (0.01) 0.05***(0.02) 0.06***(0.01) 0.06***(0.01) 0.06***(0.01)
No. obs. 381 381 381 381 381 381
R-squared 0.5083 0.4980 0.4637 0.4646 0.4722 0.4711
Adj. R-squared 0.4977 0.4872 0.4522 0.4531 0.4608 0.4598

Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods included: 15 years (2005–2019). ***
designates statistical significance at 1 %, ** at 5% and * at 10 %.

8
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

than other countries and hence higher costs of government indebtedness. This result can be correlated with the conclusion formulated
by the European Commission (2008) report, which uncovers a relatively strong core-periphery pattern, with South-Eastern countries
faring worse in terms of climate change. Thus, the manifestation of climate change pressures in these countries is expected to put
further weight on the sovereign borrowing cost.
This finding stands also for Mediterranean countries, in terms of the bio-geographical affiliation, meaning that investing in
Mediterranean countries’ sovereign bonds is perceived as bearing higher risk, and hence investors demand for adequate risk
compensation through a higher yield. At the opposite are the Atlantic and Boreal countries, which experience lower sovereign bond
yields (negative relationship with the dependent variable). Our results are complementing the ones in the European Commission
(2008) report, which emphasise that countries in the Mediterranean part of Europe seem to be more exposed to climate change
challenges, whereas Northern and Western ones appear to be less exposed at risk.
Both the Climate Change Performance Index (CCPI) and the Climate Risk Index are negatively related with sovereign yields,
suggesting that whenever a country’s performance in implementing climate-related public policies and its ability to withstand the
adverse effects of weather-related events are improving, it is perceived as less risky and sovereign yields are decreasing. Our findings
are in line with Crifo et al. (2017) reasoning, which have noticed the same pattern but for countries showing good ESG performance. A
similar conclusion is reached by Mallucci (2020), through an empirical investigation on how natural disasters can exacerbate fiscal
vulnerabilities and trigger sovereign defaults. An increase in the manifestation of extreme-weather risks is able to diminish govern­
ment’s ability to issue new debt and has an adverse impact on government’s borrowing conditions.
With regard to our newly developed indicator – the climate financial liabilities – it shows a positive relationship with the dependent
variable. This is a fact that confirms our expectation: a higher level of climate liability will incur higher fiscal risks and hence higher
sovereign yields to compensate for the increased uncertainty and risk witnessed by investors on the sovereign debt market. This result
is in line with similar research that uncovered the same positive link between climate risk vulnerability and sovereign bond yields and
spreads (Volz et al. 2020; Cevik and Jalles, 2020; Beirne et al. 2021a,b). In our case, a country’s vulnerability to climate risk may be
associated with potentially higher carbon costs due to the country’s larger amounts of CO2 emissions.
The second baseline model exhibiting the sovereign bond yields spread as the dependent variable is tested, with exactly the same
model specifications as the preceding one. The results are presented in Table 4.
Irrespective the models’ specifications in terms of the various country-level dummies, the macroeconomic and fiscal control
variables maintain their statistical significance and sign in relation with the sovereign bond yields spread, confirming the economic
theory.
Being a euro-area country implies lower sovereign bond spread (lower risk premium) compared to non-euro-area countries, while a
country’s geographical inclusion into the South-Eastern part of Europe is associated with higher spreads than North-Western ones.
Also, countries in the Atlantic bio-geographical region experience lower spreads than other regions.
Climate liabilities are always in a high statistical significance and negative relationship with spread, suggesting that an increase in
their level determines a further reduction of the risk premium. In our opinion this finding may be due to the fact that market par­
ticipants are not fully aware of this new type of liability, or on a shorter-term they are concerned more about direct, explicit gov­
ernment liabilities and to a lower extent about the potential liabilities and their realization outlook, therefore they do not price it
appropriately by asking for a higher risk premium.
The Climate Risk Index preserves its negative sign, indicating that improvements in a country’s capability to counteract the adverse
effects of weather-related events causes a decline in both the sovereign bond yields and spreads.

Table 4
The determinants of sovereign bond yields spread.
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

gov. deficit/ surplus in GDP -0.06*** (0.01) -0.06*** (0.01) -0.05*** (0.02) -0.06*** (0.01) -0.07*** (0.07) -0.06*** (0.01)
gov. debt/GDP 0.03*** (0.01) 0.03*** (0.01) 0.03*** (0.01) 0.03*** (0.01) 0.22*** (0.09) 0.03** (0.01)
Sov. rating 0.10*** (0.01) 0.08*** (0.02) 0.11*** (0.02) 0.11*** (0.01) 0.23*** (0.05) 0.10*** (0.01)
GDP growth rate -0.002 (0.02) -0.002 (0.02) -0.004 (0.02) -0.003 (0.02) -0.32 (0.09) -0.003 (0.02)
inflation rate 0.11*** (0.02) 0.13*** (0.02) 0.11*** (0.03) 0.12*** (0.02) 0.28*** (0.09) 0.12*** (0.02)
Dummy euro-zone -0.26** (0.12)
Dummy SE Europe 0.29*** (0.11)
Dummy Mediterranean -0.11 (0.14)
Dummy Continental 0.18 (0.12)
Dummy Atlantic -0.33** (0.13)
Dummy Boreal -0.11 (0.11)
CCPI 0.007 (0.005) 0.006 (0.005) 0.005 (0.004) 0.005 (0.005) 0.006 (0.005) 0.005 (0.005)
Climate Risk Index -0.006*** (0.002) -0.005*** (0.002)* -0.005*** (0.002) -0.005*** (0.002) -0.005*** (0.002) -0.005*** (0.002)
Climate liabilities -0.13*** (0.03) -0.16*** (0.03) -0.13*** (0.03) -0.15*** (0.03)* -0.13** (0.02) -0.14*** (0.03)
No. obs. 190 190 190 190 190 190
R-squared 0.6186 0.6545 0.5956 0.6009 0.5971 0.5927
Adj. R-squared 0.6017 0.6392 0.5777 0.5832 0.5793 0.5747
***
Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods included: 15 years (2005–2019).
designates statistical significance at 1 %, ** at 5% and * at 10%.

9
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

4.2. Robustness checks

To verify the consistency of our initial results to various modelling choices, we also conducted a robustness analysis for each of the
two baseline model specifications. First, we replaced the three initial climate change proxies with two other indices, namely the
Climate vulnerability and the Climate readiness (Table 5). Further, we included the primary balance as percent of GDP in our list of
control variables and removed the fiscal balance/GDP from the list. Finally, we replaced the climate change indicators with additional
distress ones (Table 6).
These estimates confirm our baseline results, the economic, fiscal, and dummy variables’ maintaining their statistical significance
and sign. Regarding the two climate change indices provided by ND-GAIN, their sign and significance is in line with the one exhibited
by previous research in this field (Cevik and Jalles, 2020; Volz et al., 2020; Beirne et al., 2021a,b) which uncovers that the magnitude
of the climate effect on sovereign bond yields is higher for countries deemed highly vulnerable to climate change. Specifically, higher
climate vulnerability is compatible with increasing sovereign yields, while higher readiness is associated with a downward pattern of
yields.
By adding the primary balance/GDP as a control variable, there is no striking finding compared with the previous estimates. Both
indices that proxy for the increased risk and distress on the sovereign debt market, and respectively on the overall financial market
record a positive sign. Hence, they are precursors of an environment characterized by upward sovereign bond yields.
The same model specifications have been tested also for the second baseline model, having the spread as dependent variable. The
overall results remained essentially unchanged and are available in Appendix 2 (illustrates the findings obtained when using additional
climate risk indices) and Appendix 3 (accounts for financial stress and global uncertainty indicators).
Accounting for the same set of macroeconomic controls, only the climate readiness index appears to significantly determine the
evolution of sovereign bond spreads in the sense that the risk premium incorporated by investors into long-term sovereign bonds is
decreasing when a country shows good management capabilities of its climate challenges.
Being perceived as potential liabilities to be realised in the future, in case an adverse event occurs, the levels of climate liabilities
seem not to be adequately priced by market participants; hence the negative relationship between these climate liabilities and spreads.
On the contrary, the signals transmitted by the Climate Risk Index seem to be better understood and interpreted by the market par­
ticipants, this information being further incorporated into lower spreads. Increased financial stress on the equity markets, bond
markets and foreign exchange markets (symbolised by the CLIFS index) appears not to impact the sovereign spread in the sense of
increased risk premiums asked for by investors on the sovereign debt market (negative sign with the spread). Rather, investors are
more concerned about the escalating distress on the sovereign debt market, as the increase of the SovCISS index level triggers a further
increase of the spread (positive link).

4.3. Estimating the individual impact of leading variables on the sovereign bond yields and spread

The final stage of our analysis consists in estimating the strength of impact among the significant leading variables on both metrics
for the sovereign borrowing cost. Furthermore, we reveal whether the various climate change metrics are more or less significant than
other economic and fiscal variables we took into account in the baseline model.
To account for the size effect of individual leading variables we apply a parsimonious model, with only one independent variable at
a time. We consider only those variables that proved their statistical significance in the initial multivariate panel regression. Our
approach is in line with Sullivan and Feinn (2012) who explain that the presence of a statistical significance (reflected by the P-value)
indicates that an effect exists between the dependent and independent variables, but however it cannot also reveal the size or

Table 5
The determinants of sovereign bond yields (two alternative climate risk measures).
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

gov. deficit/ surplus in GDP -0.05*** (0.009) -0.04*** (0.008) -0.04*** (0.008) -0.04*** (0.009) -0.05*** (0.008) -0.04*** (0.009)
gov. debt/GDP 0.02*** (0.004) 0.02*** (0.004) 0.02*** (0.005) 0.02*** (0.005) 0.02*** (0.005) 0.02*** (0.005)
Sov. rating 0.005 (0.01) 0.0002 (0.01) 0.004 (0.01) 0.006 (0.01) 0.003 (0.01) 0.007 (0.01)
GDP growth rate -0.01 (0.008) -0.01 (0.008) -0.01 (0.008) -0.01 (0.009) -0.01 (0.008) -0.01 (0.009)
inflation rate 0.11*** (0.01) 0.11*** (0.01) 0.13*** (0.01) 0.12*** (0.01) 0.12*** (0.01) 0.12*** (0.01)
Dummy euro-zone -0.11 (0.08)
Dummy SE Europe 0.25*** (0.07)
Dummy Mediterranean 0.15** (0.06)
Dummy Continental -0.05 (0.07)
Dummy Atlantic -0.15* (0.09)
Dummy Boreal -0.11 (0.10)
Climate vulnerability 3.16*** (0.7) 2.49*** (0.68) 3.08*** (0.63) 3.38*** (0.66) 3.34*** (0.67) 3.31*** (0.68)
Climate readiness -0.31 -0.26 -0.51** (0.24) -0.54** (0.25) -0.49* (0.279) -0.51* (0.28)
(0.32) (0.27)
No. obs. 456 456 456 456 456 456
R-squared 0.5069 0.5088 0.4838 0.4895 0.4978 0.4950
Adj. R-squared 0.4992 0.5011 0.4758 0.4815 0.4899 0.4871

Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods included: 18 years (2001–2018). ***
designates statistical significance at 1 %, ** at 5% and * at 10 %.

10
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

Table 6
The determinants of sovereign bond yields (various distress indicators).
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

gov. deficit/ surplus in -0.06*** (0.02) -0.06*** (0.02) -0.06*** (0.02)

GDP
gov. debt/GDP 0.03***(0.006) 0.03***(0.006) 0.02***(0.007) 0.02** (0.008) 0.03*** (0.007) 0.02*** (0.008)
primary balance -0.07***(0.01) -0.07***(0.01) -0.06***(0.01)
Sov. rating 0.04*** (0.01) 0.02*(0.01) 0.04***(0.01) 0.03 -0.01 0.02
(0.02) (0.02) (0.02)
GDP growth rate 0.004 (0.01) 0.001 (0.01) 0.002 (0.01) 0.0001 (0.02) -0.003 (0.009) -0.0008 (0.01)
inflation rate 0.11***(0.01) 0.14***(0.02) 0.15***(0.02) 0.23*** (0.03) 0.19*** (0.03) 0.22*** (0.03)
Dummy euro-zone -0.36***(0.07) 0.03
(0.09)
Dummy SE Europe 0.39*** (0.08) 0.44*** (0.09)
Dummy Mediterranean 0,08 0.19** (0.09)
(0.09)
CCPI -0.003** (0.001) -0.003*(0.001) -0.004***(0.001)
Climate Risk Index -9.97e-05*** (1.41e- -8.82e-05***(1.65e- -0.0001***(1.66e-
05) 05) 05)
Climate liabilities 0.07*** (0.02) 0.02 0.03** (0.02)
(0.02)
SovCiss 1.16*** (0.31) 1.11*** (0.33) 0.99*** (0.35)
CLIFS 0.76* (0.39) 1.21*** (0.45) 1.08** (0.44)
WUI -0.18 -0.21 -0.26
(0.33) (0.39) (0.36)
No. obs. 381 381 381 303 303 303
R-squared 0.5482 0.5166 0.4825 0.4303 0.4722 0.4473
Adj. R-squared 0.5385 0.5062 0.4713 0.4148 0.4579 0.4322

Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods included: 18 years (2005–2019) for
models 1–3, respectively 20 years (2001–2020) for models 4–6. *** designates statistical significance at 1 %, ** at 5% and * at 10 %.

magnitude of this effect.

Thus, we run separate univariate panel regressions and rank each independent variable according to the R-squared value. This is a
method used in the economic literature (Sullivan and Feinn, 2012; Maher et al., 2017) to assess which explanatory variable is the most
important in a given dataset. The focus is on R-squared as a statistical indicator because it represents the proportion of the variation of
the dependent variable that is explained by the independent variable included in the regression model. In other words, it indicates the
extent to which the variation of one independent variable (economic, fiscal, or climate-related) explains the variation of the sovereign
borrowing cost.
Tables 7 and 8 synthesise the results from a parsimonious univariate specification having sovereign bond yields, and respectively
spread as dependent variables.
In terms of the individual effect exerted by each leading variable on the sovereign bond yields, results indicate that economic
fundamentals (inflation rate) and the fiscal space indicators (fiscal balance, debt/GDP) play a major role. Among the climate change
metrics, the most influential for the variation of yields are the Climate readiness index and Climate vulnerability index, followed by the
Climate Change Performance Index. The last five positions in this ranking are occupied by various climate-related indicators, such as
the Climate Risk Index, climate liabilities and three bio-geographical proxies closely related to countries’ climate change character­
istics. Therefore, a country’s inclusion into the Mediterranean, Atlantic or Boreal bio-regions impacts the dynamics of their domestic
sovereign yields. Climate liabilities are positioned on the last place, having the least impact on the dependent variable. This result is not

Table 7
Individual size effect for sovereign bond yields’ leading factors.
Variable R-squared Ranking

Inflation rate 0.2192 1

Gov. deficit/ surplus in GDP 0.1977 2
Climate readiness 0.1553 3
Gov. debt/GDP 0.1418 4
Climate vulnerability 0.1321 5
Euro-zone membership 0.1012 6
Geographical membership 0.0867 7
Climate Change Performance Index 0.0619 8
Sovereign rating 0.0479 9
Climate Risk Index 0.0343 10
Mediterranean region 0.0266 11
Atlantic region 0.0168 12
Boreal region 0.0130 13
Climate liabilities 0.0040 14

11
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

Table 8
Individual size effect for spread leading factors.
Variable R-squared Ranking

Sovereign rating 0.4050 1

Climate readiness 0.3472 2
Geographical membership 0.2518 3
Gov. deficit/ surplus in GDP 0.1903 4
Atlantic region 0.1671 5
Inflation rate 0.1491 6
Gov. debt/GDP 0.1274 7
Euro-zone membership 0.0832 8
Climate Risk Index 0.0279 9
Climate liabilities 0.0231 10

surprising, given the novel type of information it provides and correlating this with the statistical relationship established also with the
spreads.
Table 8 shows that the size effects of economic, fiscal, and climate-related variables are more amalgamated than in the case of yield
determinants. The proxy for the sovereign rating is placed on the first order of importance in relation with the sovereign spread, while
in the second place we can find a climate proxy. Economic and fiscal variables still play an important role in influencing the variation of
spreads, but they do not occupy the first positions in the ranking. With regards to the various approaches for the climate change
metrics, the Climate readiness index seems to exert the most influence on spread variation, followed at great distance by Climate Risk
Index and climate liabilities. A country’s inclusion in the Atlantic bio-region kept its impact also on the spread. Climate liabilities are
placed again last, having the least impact on both yields and spreads.
The main conclusion to be drawn from this comparative assessment of the size effect determined by individual leading variables on
both yields and spread is straightforward: even in most cases the climate-related proxies exert an effect that is weaker compared with
the one of macroeconomic fundamentals, the market players recognise their important role and use them in a complementary manner.
A similar conclusion was reached by Crifo et al. (2017), although their scope had been to investigate the effect triggered by ESG-related
proxies on the sovereign borrowing cost measured through spreads.

5. Conclusions

The paper brings a new perspective against the existing background, by focusing exclusively on European Union countries to
uncover whether their government borrowing costs are impacted by climate change developments and which is the size effect,
compared with traditional economic and fiscal leading factors. Existing empirical studies, although scarce, followed a different
approach by considering particularly those countries vulnerable to climate risks due to their geographical location and exposure to
climate hazards.
Overall, our findings reveal that climate-vulnerable countries, exhibiting low climate disaster managerial abilities and poor per­
formance in designing and implementing adequate policies to mitigate the adverse effects of the climate challenges have to pay a
higher risk premium on their sovereign debt. Conversely, well-prepared countries that succeed in tackling climate risks benefit from
lower government borrowing costs because investors accept being paid a lower risk premium. This is in line with previous conclusions
made by Crifo et al. (2017) or Beirne et al. (2021a,b). Three out of five climate change metrics are statistically significant in relation
with sovereign bond yield spreads, while all the five proxies exert a significant influence on the sovereign yield evolution.
New findings are provided by the various dummies used. Euro-area member countries exhibit lower sovereign bond yields and
spreads than non-member countries. South-Eastern Europe countries confront with higher sovereign yields and spreads than other
countries.
The classification of EU countries into different bio-geographic regions, according to the observed and projected climate change
patterns, shows that Atlantic-region countries experience both lower sovereign bond yields and spreads while Mediterranean countries
face higher yields.
Results also emphasize that countries showing lower fiscal space and impaired fiscal and economic indicators have to pay higher
yields when issuing sovereign bonds and witness larger spreads.
Summing up, our conclusions indicate that climate change will have an increasing impact on the sovereign debt market. Therefore,
in response to the above dependencies and the growing interest of investors in the climate liabilities, we recommend that the climate
risk be included in the objectives, tasks and risk management by sovereign debt managers in EU countries. An interesting approach
would be to develop EU standards (guidelines) in this field. For now, we can also notice the important limitation regarding the lack of
unified internal and external (including sovereign ratings) methodology of risk assessment take into account the climate change impact
on government debt portfolio.

Statement

We confirm that our research is original and neither this manuscript nor any parts of its content are currently under consideration
or published in another journal. The authors confirm there are no competing interests to declare.

12
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

Acknowledgements

The article was prepared through the project financed within the Regional Excellence Initiative Programme of the Minister of
Science and Higher Education of Poland, covering the years 2019–2022, grant no. 004/RID/2018/19, financing of 3,000,000 PLN.

Appendix 1. Descriptive statistics of the variables for the whole sample

Mean Median Maximum Minimum Std. Dev.

YLD 3.52 3.41 22.50 0.09 2.59

SPR 0.23 -0.01 22.71 -6.03 2.46
BB -2.84 -2.50 5.10 -32.10 4.00
DBT 75.32 68.65 186.20 23.60 35.04
PB -5.37 -5.10 3.70 -34.90 4.73
SR 4.28 2.50 21.00 1.00 4.27
GDP 1.59 1.80 25.20 -10.10 3.26
IR 1.72 1.70 7.90 -1.70 1.42
D1 0.69 1.00 1.00 0.00 0.46
D2 0.44 0.00 1.00 0.00 0.50
D3 0.25 0.00 1.00 0.00 0.43
D4 0.44 0.00 1.00 0.00 0.50
D5 0.25 0.00 1.00 0.00 0.43
D6 0.13 0.00 1.00 0.00 0.33
CCPI 51.12 56.05 77.76 -30.00 19.77
CRI 68.08 65.38 154.50 13.83 25.83
CL 6206.34 3193.62 30,151.46 1245.15 6633.39
CRV 0.32 0.32 0.37 0.29 0.02
CRR 0.65 0.63 0.82 0.49 0.10
SovCISS 0.21 0.12 0.95 0.02 0.21
CLIFS 0.13 0.09 0.57 0.02 0.10
WUI 0.08 0.00 0.67 0.00 0.13

Appendix 2. The determinants of sovereign bond spread (two alternative climate risk measures)

Model 1 Model 2 Model 3

Gov. deficit/ surplus in GDP -0.06*** -0.06*** -0.06*** (0.02)

(0.01) (0.02)
Gov. debt/GDP 0.05*** 0.04*** 0.05***
(0.01) (0.01) (0.01)
Sov. rating 0.12*** 0.12*** 0.13***
(0.02) (0.02) (0.02)
GDP growth rate -0.01 -0.01 -0.01
(0.01) (0.01) (0.01)
Inflation rate 0.09*** 0.10*** 0.08***
(0.02) (0.02) (0.02)
Dummy euro-zone -0.32**
(0.13)
Dummy SE Europe -0.09
(0.14)
Dummy Mediterranean -0.33**
(0.14)
Climate vulnerability 0.43 1.53 0.72
(1.11) (1.005) (1.02)
Climate readiness -2.29*** -3.13*** -2.69*** (0.43)
(0.55) (0.41)
No. obs. 263 263 263
R-squared 0.6415 0.6235 0.6413
Adj. R-squared 0.6317 0.6132 0.6315
Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods
included: 18 years (2001–2018). *** designates statistical significance at 1 %, ** at 5 % and * at 10 %.

13
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

Appendix 3. The determinants of sovereign bond spread (various distress indicators)

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Gov. deficit/ surplus in GDP -0.02 -0.01 -0.01

(0.02) (0.03) (0.03)
gov. debt/GDP 0.04***(0.01) 0.03***(0.01) 0.03***(0.01) 0.004 (0.006) 0.02 0.01
(0.02) (0.01)
Primary balance -0.06***(0.01) -0.06***(0.01) -0.05***(0.01)
Sov. rating 0.10*** (0.01) 0.08***(0.02) 0.11***(0.02) 0.05*** (0.02) 0.04** (0.02) 0.06*** (0.01)
GDP growth rate 0.001 (0.02) 0.0008 (0.02) -0.003 (0.02) -0.06*** (0.02) -0.12*** (0.04) -0.11*** (0.03)
Inflation rate 0.11***(0.02) 0.13***(0.02) 0.12***(0.02) 0.03 -0.05 0.01
(0.05) (0.09) (0.07)
Dummy euro-zone -0.33***(0.12) -1.66*** (0.11)
Dummy SE Europe 0.31*** (0.10) 0.06
(0.31)
Dummy Mediterranean -0.20 -0.99*** (0.21)
(0.14)
CCPI 0.01 (0.005) 0.006 (0.005) 0.01 (0.005)
Climate Risk Index -0.01*** (0.002) -0.006***(0.002) -0.01***(0.002)
Climate liabilities -0.14*** (0.03) -0.17***(0.03) -0.14***(0.03)
SovCiss 3.84*** (0.22) 2.00*** (0.75) 3.21*** (0.51)
CLIFS -1.68** (0.74) -3.96*** (1.30) -4.74*** (1.13)
WUI -0.63 -0.24 0.04
(0.70) (1,10) (1.08)
No. obs. 390 390 390 320 320 320
R-squared 0.6222 0.6277 0.5927 0.7490 0.4059 0.5106
Adj. R-squared 0.6055 0.6112 0.5747 0.7348 0.3725 0.4831
Note: Control variables enter the regression in lagged values, excepting the Moody’s sovereign rating. Periods included: 15 years (2005–2019) for
models 1–3, respectively 20 years (2001–2020) for models 4–6. *** designates statistical significance at 1 %, ** at 5 % and * at 10 %.

References

Afonso, A., Arghyrou, M.G., Kontonikas, A. , 2015. The determinants of sovereign bond yield spreads in the EMU, ECB Working Paper, No. 1781, ISBN 978–92-
899–1594-6, European Central Bank.
Agarwala, M., Burke, M., Klusak, P., Mohaddes, K., Volz, U., Zenghelis, D. 2021. Climate Change and Fiscal Sustainability: Risks and Opportunities. CAMA Working
Paper No. 80/2021. 〈https://doi.org/10.2139/ssrn.3924044〉.
Ahir, H., Bloom, N., Furceri, D. , 2020. 60 Years of Uncertainty, Finance & Development, March 2020, vol. 57, no. 1, 〈https://www.imf.org/external/pubs/ft/fandd/
2020/03/imf-launches-world-uncertainty-index-wui-furceri.htm〉.
Ahir, H., N. Bloom, D. Furceri, 2018. World Uncertainty Index, available at SSRN: 〈https://ssrn.com/abstract=3275033〉, https://doi.org/10.2139/ssrn.3275033.
Attinasi, M.-G., Checherita, C., Nickel, C. , 2009. What explains the surge in Euro area sovereign spreads during the financial crisis of 2007–09? European Central
Bank, WP No. 1131.
Bank for International Settlements, 2021. Climate-related risk drivers and their transmission channels, 〈https://www.bis.org/bcbs/publ/d517.pdf〉.
Barros, L.A.B.C., Bergmann, D.R., Castro, F.H., Di Miceli da Silveira, A., 2020. Endogeneity in panel data regressions: methodological guidance for corporate finance
researchers. Revista Brasileira de Gestão de Negócios 22 (spe), 437–461. https://doi.org/10.7819/rbgn.v22i0.4059.
Beirne, J., Renzhi, N., Volz, U., 2021a. Bracing for the typhoon: climate change and sovereign risk in Southeast Asia. Sustain. Dev. 1–15. https://doi.org/10.1002/
sd.2199.
Beirne, J., Renzhi, N., Volz, U., 2021b. Feeling the heat: climate risks and the cost of sovereign borrowing. Int. Rev. Econ. Financ. 76, 2021. https://doi.org/10.1016/j.
iref.2021.06.019.
Bouis, R. , 2019. Banks’ Holdings of Government Securities and Credit to the Private Sector in Emerging Market and Developing Economies. IMF Working Papers WP/
19/224. Washington: International Monetary Fund.
Bruha, J., Kocenda, E., 2018. Financial stability in Europe: banking and sovereign risk. J. Financ. Stab. 36, 305–321.
Burck, J., Hagen, U., Höhne, N., Nascimento, L., Bals, C. 2020. Climate Change Performance Index 2021, 〈https://ccpi.org/download/the-climate-change-
performance-index-2021/〉.
Capelle-Blancard, G., Crifo, P., Diaye, M.A., Oueghlissi, R., Scholtens, B., 2019. Sovereign bond yield spreads and sustainability: an empirical analysisof OECD
countries. J. Bank. Financ. 98 (2019), 156–169.
Carney, M. , 2015. Breaking the tragedy of the horizon –climate change and financial stability, speech given at Lloyd’s of London, Bank of England.
Centre for Sustainable Finance, 2021. Climate change and sovereign risk, October.
Cevik, S., Jalles, J.T. , 2020. This changes everything: climate shocks and sovereign bonds, IMF Working Paper WP/20/79.
CFA, 2021. Country risk, 〈https://analystnotes.com/cfa-study-notes-describe-uses-of-country-risk-premiums-in-estimating-the-cost-of-equity.html〉.
Chen, C., Noble, I., Hellmann, J., Coffee, J., Murillo, M., Chawla, N. , 2015. University of Notre Dame Global Adaptation Index. Country Index Technical Report.
Crifo, P., Diaye, M.A., Oueghlissi, R., 2017. The effect of countries’ ESG ratings on their sovereign borrowing costs. Q. Rev. Econ. Financ. 66 (2017), 13–20.
ECB/ESRB, 2021. Climate-related risk and financial stability, ECB/ESRB Project Team on climate risk monitoring, European Central Bank and European Systemic Risk
Board.
Eckstein, D., Kunzel, V., Schafer, L. , 2021. Global climate risk index 2021, 〈https://germanwatch.org/sites/default/files/Global%20Climat%20Risk%20Index%
202021_2.pdf〉.
Ehlers, T. Mojon B., Packer F. , 2020. Green bonds and carbon emissions: exploring the case for a rating system at the firm level, BIS Quarterly review, September.
ESG - Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable
investment, and amending Regulation (EU) 2019/2088.
European Central Bank, 2021. Climate-related risk and financial stability.
European Commission, 2008. Regions 2020. An assessment of future challenges for EU regions, Commission Staff Working Document, Brussels (2008), 〈https://ec.
europa.eu/regional_policy/sources/docoffic/working/regions2020/pdf/regions2020_en.pdf〉.

14
I.A. Boitan and K. Marchewka-Bartkowiak Research in International Business and Finance 62 (2022) 101685

European Environment Agency, 2020. Key observed and projected climate change and impacts for the main regions in Europe, 〈https://www.eea.europa.eu/data-and-
maps/figures/key-past-and-projected-impacts-and-effects-on-sectors-for-the-main-biogeographic-regions-of-europe-5〉.
Fama, E.F., 1976. Foundations of Finance: Portfolio Decisions and Securities Prices. Basic Books, New York.
Fatica, S., Panzica, R., 2020. Green Bonds as a Tool Against Climate Change?. JRC Technical report. European Commission,.
Fender, I., McMorro, M., Sahakyan, V., Zulaica O., 2019. Green bonds: the reserve management perspective, BIS Quarterly Review.
González-Fernández, M., González-Velasco, C., 2018. Bond yields, sovereign risk and maturity structure. Risks 6 (4), 109. https://doi.org/10.3390/risks6040109.
Gruber, J.W., Kamin, S.B., 2012. Fiscal positions and government yields in OECD countries. J. Money, Credit Bank. 44 (8), 1563–1587.
High-Level Commission on Carbon Prices, 2017. Report of the High-Level Commission on Carbon Prices. World Bank, Washington, DC.
Hilscher, J., Nosbusch, Y., 2010. Determinants of sovereign risk: macroeconomic fundamentals and the pricing of sovereign debt. Rev. Financ. 14, 235–262.
Intergovernmental Panel on Climate Change, 2021. Climate Change 2021. The Physical Science Basis, 〈https://www.ipcc.ch/report/ar6/wg1/〉.
Kling, G., Lo, Y.C., Murinde, V., Volz, U. , 2018. Climate Vulnerability and the Cost of Debt, 〈https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3198093〉.
Klusak, P., Agarwala, M., Burke, M., Kraemer, M., Mohaddes, K. , 2021. Rising temperatures, falling ratings: The effect of climate change on sovereign
creditworthiness. CAMA Working Paper No. 34/2021. 〈https://doi.org/10.2139/ssrn.3811958〉.
Kumar, R., 2016. Efficient Capital Markets and its Implications, in the Book Valuation. Academic Press, pp. 73–91. https://doi.org/10.1016/B978-0-12-802303-
7.00003-6.
Laeven, L., Valencia, F., 2018. Systemic Banking Crises Revisited. IMF Working Paper No. 18/206. International Monetary Fund, Washington, DC.
Maher, J.M., Markey, J.C., Ebert-Ma, D., 2017. The other half of the story: effect size analysis in quantitative research. CBE—Life Sci. Educ. 12 (3) https://doi.org/
10.1187/cbe.13-04-0082.
Mallucci, E. , 2020. Natural disasters, climate change, and sovereign risk, FRB International Finance Discussion Paper No. 1291, 〈https://doi.org/10.17016/IFDP.
2020.1291〉.
Marchewka-Bartkowiak, K. , 2021. Sovereign climate debt management - a new approach to reducing fiscal risk, the article presented at the Wolpertinger 2021
Conference in Banking and Finance, Cracow, 1–4 September 2021.
Mitchell, I., Robinson, L., Tahmasebi, A. 2021. Valuing climate liability, center for global development, CGD Note, January 2021.
Schuknecht, L., Von Hagen, J., Wolswijk, G., 2009. Government risk premiums in the bond market: EMU and Canada. Eur. J. Political Econ. 25, 371–384.
Sehgal, S., Mathur, S., Arora, M., Gupta, L., 2018. Sovereign ratings: determinants and policy implications for India. IIMB Manag. Rev. 30 (2), 140–159. https://doi.
org/10.1016/j.iimb.2018.01.006.
SFDR - Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services
sector.
Standard & Poor’s Ratings Services, 2014. Climate Change is a Global Mega-Trend for Sovereign Risk. RatingsDirect, 15 May.
Sullivan, G.M., Feinn, R., 2012. Using effect size-or why the P value is not enough. J. Grad. Med. Educ. 4 (3), 279–282. https://doi.org/10.4300/JGME-D-12-00156.1.
Volz, U., J. Beirne, Preudhomme, N.A., Fenton, A., E. Mazzacurati, N. Renzhi, J. Stampe , 2020. Climate change and sovereign risk. London, Tokyo, Singapore, and
Berkeley, CA: SOAS University of London, Asian Development Bank Institute, World Wide Fund for Nature Singapore, and Four Twenty Seven, 〈https://doi.org/
10.25501/SOAS.00033524〉.
World Bank and the International Monetary Fund, 2002. Guidelines for Public Debt Management: Accompanying Document, November 21.
Zenios, S.A. , 2021. The risks from climate change to sovereign debt in Europe, Bruegel, Policy Contribution, Issue No 16.
Zunino, L., Fernandez Bariviera, A., Belen Guercio, M., Martinez, L.B., Rosso, O.A., 2012. On the efficiency of sovereign bond markets. Phys. A 2012. https://doi.org/
10.1016/j.physa.2012.04.009.

15