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Borsa Istanbul Review 23-S1 (2023) S84–S95
http://www.elsevier.com/journals/borsa-istanbul-review/2214-8450

Full Length Article

Does climate change affect sovereign credit risk? International evidence

Nader Naifar
Imam Mohammad Ibn Saud Islamic University (IMSIU), Riyadh, Saudi Arabia
Received 28 July 2023; revised 4 October 2023; accepted 4 October 2023
Available online 10 October 2023

Abstract

This paper fills a crucial research gap by investigating the connection between climate change and sovereign credit risk. While the economic
implications of climate risk have long been acknowledged, limited attention has been given to understanding its impact on sovereign credit risk.
To address this gap, we provide novel empirical evidence on the influence of climate change readiness and vulnerability on sovereign credit
default swaps (SCDS). Utilizing a panel quantile regression approach, our study reveals the following key findings: (i) Climate change readiness
harms SCDS spreads across all quantiles; (ii) Climate change vulnerability positively affects SCDS spreads, except for the extreme upper quantile;
and (iii) The relationship between climate change readiness and SCDS spreads is particularly pronounced in higher quantiles. By shedding light on
these relationships, our analysis offers fresh insights into the intricate dynamics between climate change and sovereign credit risk.
Copyright © 2023 Borsa İstanbul Anonim Şirketi. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license
(http://creativecommons.org/licenses/by-nc-nd/4.0/).

JEL classification: C2; C22; G15; G1

Keywords: Climate changes; Sovereign credit risk; Panel quantile regression; Sovereign credit default swap

1. Introduction Consequently, countries with a weak capacity for climate

The urgency of climate change is increasingly affecting the
global economy and financial markets. Weather catastrophes,
such as droughts, hurricanes, and flooding, are becoming more
frequent due to climate change, with dire consequences for the
world's economic system. Thus, businesses, investors, financial
institutions, governments, and regulators must understand how
climate change affects systemic risks, how to value these risks,
and how to manage them. Different countries have different
vulnerabilities to weather anomalies due to climate change.
Some countries with solid physical infrastructures and sub-
stantial economies, such as China and the U.S., may be able to
adapt quickly to climate change (Yang & Hamori, 2023).
However, the infrastructure to safeguard travel, communica-
tion, and health from climate extremes in developing countries
is typically rudimentary (Ward & Shively, 2012).
E-mail address: naneifar@imamu.edu.sa.
Peer review under responsibility of Borsa İstanbul Anonim Şirketi.
change adaptation may have a greater systemic exposure to the
global economy, affecting the cost of sovereign borrowing and
raising their sovereign credit risk.
Climate change poses significant risks to both the environ-
ment and the global economy. As the frequency and intensity
of extreme weather events increase, countries face growing
challenges in terms of their readiness and vulnerability to
climate change impacts. These challenges can affect a country's
financial stability, including sovereign creditworthiness.
Extreme weather and climate changes frequently cause sizable
financial losses and social harm. The twenty-first session of the
Conference of the Parties (COP 21), or the Paris Agreement,
was one of the most significant events to achieve a new, uni-
versally applicable international climate agreement. Previous
studies have documented the impact of climate changes and
extreme weather on (i) stock market returns (e.g., Beatty and
Shimshack (2010); Pham et al. (2019); Sen and von
Schickfus (2020); Antoniuk and Leirvik (2021)); (ii) eco-
nomic growth and damage (e.g., Fankhauser and Tol (2005);
Diaz and Moore (2017); Auffhammer (2018); Tol (2018);

https://doi.org/10.1016/j.bir.2023.10.001
2214-8450/Copyright © 2023 Borsa İstanbul Anonim Şirketi. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://
creativecommons.org/licenses/by-nc-nd/4.0/).
N. Naifar
Duan et al. (2022)); (iii) banks and financial stability (e.g.,
Reghezza et al. (2022), Caby et al. (2022), Hansen (2022)); (iv)
credit rating and sovereign debt (e.g., Zenios (2022); Cevik and
Jalles (2022)); and (v) commodity prices and food securities
(e.g., Lewis and Witham (2012); Drabo, A. (2017); Fujimori
et al. (2022); Lin et al. (2022)). However, these studies do
not consider the impacts of climate change readiness and
vulnerability on SCDS spreads. Few recent studies have
investigated the impact of climate change on credit rating and
sovereign debt. Zenios (2022) described the transmission
channels from climate change to public finance, showing that
investors differentiate sovereign issuers by their climate risk
exposures. Cevik and Jalles (2022) studied the impact of
climate change on sovereign bond yields and spreads. Using
data from 98 countries from 1995 to 2017, they found that
climate vulnerability positively affects the cost of government
borrowing; however, climate resilience negatively affects the
cost of borrowing. Yang and Hamori (2023) recently investi-
gated the tail dependencies between sovereign CDSs and built
the tail network conditional on extreme oscillation regimes.
Using extreme value theory, they showed that extreme weather
amplifies its impact on the global network of sovereign credit
and significantly impacts a country's sovereign credit.
The motivation behind this research study lies in the
growing recognition of the critical interplay between climate
change, financial systems, and the stability of sovereign credit
markets. As the impacts of climate change intensify, countries
face increasing difficulties in managing climate-related risks
and adapting to changing environmental conditions. These
risks threaten their economies, public finances, and, conse-
quently, their sovereign creditworthiness. Understanding the
relationship between climate change readiness, vulnerability,
and SCDS is imperative for policymakers, investors, and
financial institutions. By investigating this relationship, this
study aims to provide valuable insights into how climate
change readiness and vulnerability influence the pricing and
trading dynamics of sovereign SCDS, enhancing risk assess-
ment frameworks, informing investment decisions, and ulti-
mately contributing to the resilience and stability of global
financial markets in the face of climate change.
This study contributes to the growing literature on climate
change in two ways. First, it offers fresh perspectives on how
climate change affects sovereign credit risk using panel quan-
tile regression. Second, it contributes to the existing literature
by adding climate variables to explain the determinants of
SCDS spreads. Most of the existing studies on SCDS spreads
focus on (i) country-specific factors and macroeconomic vari-
ables (e.g., Benkert (2004), Abid and Naifar (2006), Hilscher
and Nosbusch (2010), Beirne and Fratzscher (2013), Eyssell
et al. (2013), Simonyan and Bayraktar (2022), Boussada
et al. (2023)); and (ii) global risk factors and uncertainty
(e.g., Bouri et al. (2018), Chuffart and Hooper (2019), Naifar
and Aljarba (2023)). This paper bridges the gap between
climate science and sovereign credit risk and investigates the
impact of climate change readiness and vulnerability on sov-
ereign SCDS for developing and advanced countries. The
impact of these factors on sovereign credit risk at different
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quantiles can be estimated by applying panel quantile regres-
sion to a dataset that includes measures of climate change
readiness, vulnerability, and sovereign credit risk for multiple
countries over time. This analysis provides valuable insights
into the varying effects of climate change readiness and
vulnerability across different levels of credit risk and informs
policymakers and investors on the potential implications of
climate change for sovereign creditworthiness.
The remainder of this paper is structured as follows: Section
2 provides an overview of the theoretical background and in-
cludes a comprehensive literature review. Section 3 outlines the
methodology employed. Section 4 presents the collected data
for analysis. Section 5 examines and discusses the empirical
findings. Finally, Section 6 concludes the paper by summari-
zing the key findings and offering policy implications based on
the results.
2. Theoretical background and literature review
Climate change readiness and vulnerability are two concepts
central to assessing the impact of climate change on countries
and their economies. Climate change readiness refers to a
country's ability to adapt to and mitigate the effects of climate
change. It considers a country's institutional capacity, financial
resources, and technological capabilities to address climate
change. According to Ford and King (2015), readiness captures
the extent to which governance mechanisms and policy pro-
cedures determine the manner and timing of such adaptation. In
contrast, climate change vulnerability refers to a country's
exposure and sensitivity to climate change and its capacity to
cope and adapt. Vulnerability typically relates to a system's
susceptibility, exposure to external pressures or disturbances,
and capacity to adjust to these challenges (Smit & Wandel,
2006). According to Adger (2006), vulnerability is the pre-
disposition to experience harm due to exposure to environ-
mental and social changes, compounded by a lack of adaptive
capacity. Climate change readiness and vulnerability provide a
comprehensive understanding of a country's preparedness to
face climate change challenges. The impact of climate risk on
sovereign credit risk can be understood through three distinct
channels. First, transition risk pertains to a country's actions to
fulfill its climate commitments. Second, vulnerability arises
from the physical damage caused by climate-related events.
Finally, resilience refers to a country's preparedness to handle
climate issues. Furthermore, climate risk is gradually becoming
a potential systemic financial risk.
Countries that are highly vulnerable to climate change face
challenges that can adversely affect their economic and finan-
cial stability. For example, increased exposure to extreme
weather events, such as hurricanes, floods, or droughts, can
cause significant damage to infrastructure, agriculture, and in-
dustries, leading to economic disruptions and reduced revenue
generation. This, in turn, may strain public finances, increase
government debt levels, and hinder a government's ability to
service existing debts. Moreover, the socioeconomic conse-
quences of climate change, such as population displacement,
social unrest, and increased healthcare costs, further exacerbate
N. Naifar
the sovereign credit risk. Hence, the following hypothesis is
proposed.
H1. SCDS rises with increased vulnerability to climate
change.
In contrast, countries with higher climate change readiness are
more likely to adopt sustainable and climate-friendly policies,
which may enhance long-term economic stability and resil-
ience. By investing in renewable energy sources, implementing
carbon pricing mechanisms, and promoting energy efficiency, a
nation can reduce its reliance on fossil fuels, mitigate envi-
ronmental risks, and foster a transition toward a low-carbon
economy. These actions, in turn, contribute to a more favor-
able business environment, attract sustainable investments, and
enhance economic growth, ultimately reducing the likelihood
of sovereign credit risk. Thus, we propose the following
hypothesis.
H2. Sovereign credit default swap spreads diminish with an
improvement in readiness for climate change.
The relationship between climate change readiness, vulnera-
bility, and sovereign credit risk is an important area of research
that can inform policy decisions to address climate change
impacts on countries and their economies. There is a growing
recognition that climate change can significantly affect a
country's sovereign credit risk (e.g., Volz et al. (2020);
Angelova et al. (2021); Cevik and Jalles (2022) Yang and
Hamori (2023)) because climate change can adversely affect
a country's economy, including its ability to generate revenue,
service its debt, and attract investment. Furthermore, climate
change can increase the frequency and severity of natural di-
sasters, resulting in significant economic losses and damage to
critical infrastructure. Mallucci (2020, p. 1291) examined the
impact of natural disasters on the financial weaknesses of
Caribbean nations, leading to sovereign defaults. The author
expands upon a conventional model of sovereign defaults by
incorporating the element of disaster risk. The findings reveal
that hurricane risk diminishes a government's capacity to raise
debt, and the effects of climate change may also limit their
access to financial markets. Beirne et al. (2021, a) examined the
relationship between climate risk and the expense of borrowing
for governments. The study utilized quarterly data from
2002Q1 to 2018Q4 across 40 countries, employing fixed effect
panel data analysis. The findings indicate that susceptibility to
the direct consequences of climate change has a more pro-
nounced impact on nations' borrowing costs than climate risk
resilience. The study also reveals that the influence on bond
yields is more significant for countries highly vulnerable to
climate change. Beirne et al. (2021, b) investigated the
connection between climate change and sovereign risk in
Southeast Asia, a region heavily impacted by climate change,
leading to increased occurrences of extreme weather events that
result in economic losses and loss of life. The study empirically
examines the impact of climate change on sovereign bond
yields in six ASEAN countries by employing vulnerability and
resilience indices. The findings indicate that more vulnerable
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countries to climate change experience a significant positive
effect on sovereign bond yields, while those with greater
resilience exhibit a somewhat mitigating effect. Cevik and
Jalles (2022) studied how climate change vulnerability and
resilience affect sovereign bond yields and spreads in 98
advanced and developing countries from 1995 to 2017. The
study found that vulnerability and resilience to climate change
significantly influence the cost of government borrowing, even
after considering traditional factors that determine sovereign
risk. Countries more resilient to climate change experience
lower bond yields and spreads than countries more vulnerable
to climate-related risks. Zenios (2022) investigated the signif-
icance of incorporating climate risks into sovereign debt
analysis for institutions and investors. Using Italy as a case
study, the author explores the potential risks climate change
poses to public finance and sovereign debt while identifying
the channels through which these risks are transmitted.
Recently, Yang and Hamori (2023) explored the consequences
of climate change on the global sovereign credit default swap
markets using the daily CDS data of 57 countries from May 1,
2009, to December 31, 2020. The authors constructed a
network representing sovereign credit using extremal
connectedness, which utilizes tail dependence. They employed
a multivariate extreme value regression model with a LASSO-
type estimator to estimate tail dependence. The findings
demonstrate that severe weather events and climate-related
disasters significantly influence the risk associated with spe-
cific countries' sovereign debt, resulting in an uneven risk
transfer within the global sovereign credit network. Anand
et al. investigated the influence of Environmental, Social, and
Governance (ESG) ratings on sovereign credit risk employing
various approaches to measuring sovereign credit risk,
including market-based, structural, and analyst-based methods,
while ESG scores were derived from three different rating
agencies. By analyzing quarterly data from 2009-Q3 to 2019-
Q2, the study reveals that the sustainability performance of
corporations significantly mitigates market-based and structural
sovereign credit risk.
In this paper, we extend the research of Beirne et al. (2021, a),
Beirne et al. (2021, b), and Cevik and Jalles (2022) in two
different ways. First, we use SCDS markets instead of the
government bond markets to evaluate sovereign credit risk.
SCDS is a more accurate indicator of sovereign risk than bond
yield because it includes too much pricing information (Kim
et al., 2015; Yang & Hamori, 2023). Second, we use panel
quantile regression, which focuses on the entire conditional
distribution of the SCDS and provides a clearer picture of the
relationship between climate change and sovereign credit risk.
This research paper aims to connect climate science and sov-
ereign credit risk by examining the influence of climate change
preparedness and vulnerability on sovereign SCDS for devel-
oping and advanced nations. We seek to answer two questions:
(i) Do climate change vulnerability and readiness influence
sovereign credit default swaps? and (ii) Does the correlation
between climate change and sovereign credit risk have an
asymmetric pattern that varies across quantiles?
N. Naifar
3. Methodology
This study investigates the impact of climate change read-
iness and vulnerability on SCDS spreads after controlling for
conventional determinants of sovereign credit risk. The quan-
tile regression approach proposed by Koenker and Bassett
(1978) focuses on the entire conditional distribution of SCDS
spreads. The standard quantile regression is formulated as
follows:
Qyt (τ / Xt ) = ατ + X′t βτ (1)
where Qyt (τ /Xt ) indicates the τth conditional quantile of yt , and
Xt denotes the vector of explanatory variables. βτ and ατ
represent the estimated coefficients and unobserved effects at
quantile τ, respectively. Equation (1) does not consider unob-
served individual heterogeneity (in our case, country hetero-
geneity). To solve this issue, we apply the fixed effects panel
quantile regression approach (e.g., Canay (2011); You et al.
(2017)).1 Equation (1) is formulated as a quantile regression
of panel data:
Qyit (τ / αi , Xit ) = αi + X′it βτ (2)
where Qyit (τ / αi , Xit ) denotes the τth conditional quantile of yi,t ,
for country i in time t. According to Koenker (2004), the pa-
rameters of Equation (2) are estimated as follows:
k T N ability to leverage investments to adaptation actions. The score
(̂
β (τk , γ ), {αi (γ )}i=1 ) = arg min ∑ ∑ ∑ wk ρτk (yit − αi − Xitτ βτk )
N
N k=1 t=1 i=1
+γ ∑ |αi | (3)
i=1
where wk is the relative weight given to the τk th quantile,
which controls for the contribution of the k th quantile to the
fixed effects estimation. ρτk = c(τk −I(c < 0)) represents the
“check function,” and I (.) is an indicator function (You et al.,
2017). γ is the regulation parameter that makes the individual
effects smaller to improve the performance of the estimate of β
coefficients. The solution of Equation (3) is obtained using the
linear programming algorithm developed by Koenker and
d'Orey (1987). In this paper, we examine the impacts of
climate changes and macroeconomic variables on SCDS by
considering heterogeneity throughout the SCDS spread distri-
bution across countries. Equation (1) is formulated for the
panel quantile regression as follows:
QSCDSi,t (τ / αi , Xit ) = γ i + β1τ CCVt + β2τ MCVt (4)
where QSCDSi,t indicates the quantile of SCDS spreads, CCVt
represents the climate change variables, and MCVt indicates the
macroeconomic control variables.
1 2
Using panel data rather than time series data increases the variation in the
number of observations and reduces the noise coming from the individual time
series regressions (Westerlund et al., 2015; You et al., 2017).
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4. Data description and preliminary tests
4.1. Data description
We used annual data of SCDS from 2010 to 2020 to
investigate the impact of climate change readiness and
vulnerability on sovereign credit risk. The annual spread is
computed as the average monthly SCDS spread as downloaded
from the Bloomberg database. We used the SCDS of the
following 21 countries: Australia, Bahrain, Brazil, China,
Egypt, France, Indonesia, Italy, Japan, South Korea, Morocco,
Norway, Russia, Saudi Arabia, Spain, Sweden, Turkey, UAE,
the United Kingdom, and the United States. However, the
availability of liquid SCDS limited the selection of countries
for the study. Fig. 1 illustrates the level of SCDS (in basis
points) across countries and during the sample period.
Fig. 1 shows that Egypt presents the highest level of SCDS,
followed by Turkey, Spain, Italy, and Russia. In contrast, the
United States has the lowest level of SCDS, followed by
Norway, Sweden, and the United Kingdom.
The main explanatory variables of this study are vulnera-
bility and resilience to climate change. We used the Notre
Dame Global Adaptation Index (ND-GAIN), which measures
nations’ overall susceptibility to climate-related disruptions and
their capacity to deal with the effects. ND-GAIN combines
over 74 variables to create 45 core indicators that assess the
readiness and vulnerability of 192 UN member countries.
The readiness score is measured by considering a country's
is based on three factors: economic readiness (the environment
for investments that makes it easier to raise capital from the
private sector), governance readiness (the stability of society
and institutional structures that influence investment risks), and
social readiness (the social framework that enables an organi-
zation to use investments effectively and fairly and reap more
significant benefits from them). Fig. 2 illustrates the sample
data's country readiness score during the study period.
Fig. 2 shows that the United States, Australia, Norway, and
Sweden have higher readiness scores (the darker the green
color, the higher the readiness score). Egypt, Morocco, and
Turkey have low readiness scores.
The vulnerability score is calculated by considering how
vulnerable human societies are to climate hazards. The score is
determined by six life-supporting sectors—food, water, health,
ecosystem services, human habitat, and infrastructure. The
exposure of each sector to climate-related or climate-
exacerbated hazards, the sensitivity of that sector to the im-
pacts of the hazard, and the capacity of that sector to cope with
or adapt to these impacts are each represented by six indicators,
which together represent three cross-cutting components.2
Fig. 3 illustrates the countries’ vulnerability scores from the
sample data during the study period.
For more details, please refer to the University of Notre Dame Global
Adaptation Index Country Index Technical Report (https://gain.nd.edu/our-
work/country-index/).
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Borsa Istanbul Review 23-S1 (2023) S84–S95

Fig. 1. The level of Sovereign Credit Default Swap across times and countries.

Fig. 2. The Readiness score of the sample data from 2010 to 2020.

Fig. 3 shows that Indonesia, Mexico, Bahrain, and Egypt
have higher vulnerability scores (the darker the orange color,
the higher the vulnerability score), while Norway, Sweden, and
the United Kingdom have lower vulnerability scores.
Following the empirical literature (e.g., Remolona et al. (2008);
Basurto et al. (2010); Brandorf and Holmberg (2010); Baum
and Wan (2010); Liu and Morley (2013); Blau and Roseman
(2014); Cevik and Jalles (2022)), we apply a set of control
variables as presented in Table 1. The correlation matrix and
the mean of the panel quantile regression variables are pre-
sented in the Appendix (Tables A1 and A2).
4.2. Preliminary tests
4.2.1. Normality test
Before performing the panel quantile regression, we
checked whether the residuals of the panel model were nor-
mally distributed. Table 2 presents the descriptive statistics of
kurtosis and skewness and the Shapiro–Wilk test.
The skewness, kurtosis, and Shapiro–Wilk test values, as
presented in Table 2, indicate that the results reject the null
hypothesis of the variables conforming to a normal
distribution.

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Borsa Istanbul Review 23-S1 (2023) S84–S95

Fig. 3. The vulnerability score of the sample data from 2010 to 2020.

Table 1 where the error terms or disturbances across different panel

Panel Quantile regression variables description. units are not independent and exhibit some form of correlation
Dependent variable or interdependence. When cross-sectional dependence exists,
SCDS Sovereign credit default swap spreads this assumption is violated, leading to biased and inefficient
Climate change variables parameter estimates. Table 3 illustrates the outcomes of the
VULN Vulnerability index
cross-sectional dependence test of Breusch and Pagan (1980).
READ Readiness index Table 3 shows that the p-values reject the null hypothesis (H0):
Control variables
There is no cross-sectional dependence, indicating evidence of
cross-sectional dependence in the panel data. In other words, the
GDPG The annual percentage growth rate of GDP at market prices is
based on constant local currency
hypothesis of cross-sectional independence for SCDS, GDPG,
INFL Inflation as measured by the consumer price index INFL, CBAL, VULN, INDU, and READ is rejected, and cross-
CBAL Current account balance (the sum of net exports of goods and sectional dependence exists in these variables.
services, net primary income, and net secondary income)
INDU Industry (including construction) 4.2.3. Slope homogeneity test
The next step is estimating the panel dataset's slope homo-
Table 2 geneity test. The Pesaran and Yamagata (2008) slope homo-
Normal distribution tests.
geneity test examines whether the slopes (coefficients) of the
Skewness Kurtosis Shapiro–Wilk test independent variables are homogeneous across different in-
Statistics Significance dividuals in a panel dataset. It is beneficial when estimating a
SCDS 1.561081 5.920589 0.85716 0.00000 fixed effects panel model. Table 4 illustrates the outcomes of
GDPG −.3758441 7.623428 0.91118 0.00000 the slope homogeneity test of Pesaran and Yamagata (2008).
INFL 2.812391 16.1889 0.76252 0.00000 Table 4 shows that p-values reject the null hypothesis (H0):
CBAL 1.344394 5.905828 0.90823 0.00000
Slope coefficients are homogenous, indicating that slope co-
VULN −.0199575 2.07967 0.96099 0.00001
INDU .8428981 3.184776 0.92688 0.00000 efficients are heterogenous in the panel data.
READ .0126908 1.721886 0.93881 0.00000
Note. Significance represents the P-value at the 1% significance level. Table 3
Breusch–Pagan LM test for cross-sectional
dependence in panel.
4.2.2. Cross-sectional dependence test LM test statistic 782.18
The next step is to check the problem of cross-sectional P-value 0.0000
dependence using the Breusch and Pagan (1980) test. Cross- Note: p-values designate statistical significance at
sectional dependence in panel quantile regression occurs the 1% level.

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Borsa Istanbul Review 23-S1 (2023) S84–S95

Table 4

−8.629662***

−3.560941***

−5.199453***

Note. The SCDS is the dependent variable. The numbers in parentheses are the t-values. The asterisk (***) denotes statistical significance at the 1% level. VULN (Climate risk vulnerability), READ (Climate risk
27.39895***

2.581567***
Pesaran and Yamagata (2008) slope homogeneity test.

−2.157365
(−15.73)

(−69.30)
(252.71)
−88.42)
−8.707 −28.879

(−1.65)
Delta Delta Adj

(15.25)
95th
P-value 0.0000 P-value 0.0000
Note: p-values designate statistical significance at the 1% level.

4.2.4. Panel unit root test

Second-generation unit root tests, such as the Levin-Lin-

readiness), GDPG (The annual percentage growth rate of GDP), INFL (Inflation as measured by the consumer price index), CBAL (Current account balance), and INDU (Industry).
−7.684439***

−3.036825***

−4.616427***
17.52861***

.4766726***

.8666013***
Chu (2002) test, address the presence of slope heterogeneity

(−112.56)
and cross-sectional dependence. It accounts for cross-sectional

(−22.76)

(−67.12)
(31.16)

(5.11)

(3.77)
dependence and individual heterogeneity by employing a more

90th
general form of the ADF test. The results of the Levin-Lin-Chu
(2002) panel unit root test are show in Table 5.
Table 5 shows that p-values accept the null hypothesis (H0):
Panels contain unit roots, indicating that panels are nonsta-
tionary at the level. However, after taking the first difference,

−1.912947***

−.8510088***

−2.584482***
.2532114***
we find that all the variables exhibit stationarity, suggesting

17.8083***

2.96713***
(−54.36)

(−17.90)

(−99.85)
(898.15)
they can be classified as integrated into order one I (1). This

(39.13)
(8.25)
finding forms the foundation for the subsequent analysis, which

75th
involves examining the cointegration relationship among the
variables before estimating the coefficients for long run effects.

4.2.5. Panel cointegration test

We used Kao's Common Factor Panel Cointegration Test to
−.3350851***

−1.154897***

−.1706406***

−2.528729***
12.33499***

2.342679***
determine whether there is a long-term relationship between

(−104.26)
(−18.68)
(216.66)
variables in the panel dataset. This test assumes the presence of (−7.47)

(−5.17)

(26.99)
50th

a common factor that affects all individuals in the panel and

tests for cointegration using common factor-based methods.
Table 6 illustrates the results of the panel cointegration test.
According to Table 6, the p-values reject the null hypothesis
(H0): no cointegration, indicating a cointegration relationship
−.3607466***

between the study variables.

−1.36797***

−1.89408***
1.447713***

7.514976***

2.756233***

(−114.06)
(−69.52)

(−20.73)
(32.570)

(155.18)

(56.48)

5. Panel quantile regression results and discussion

25th

This section presents the results of the panel quantile

regression as specified in Equation (4). Table 7 reports the
−.8026891***

−.7706062***

Table 5
−1.51762***
.8758349***

7.490575***

2.629147***

Levin-Lin-Chu (LLC) test.

(−300.42)
(1152.63)

(−87.69)

(−89.97)
(133.13)

(251.01)

Variables Level First difference

10th

SCDS −0.5005 −3.1088***

GDPG 1.8096 −5.4863***
INFL −0.5033 −9.3242***
CBAL 0.6661 −4.0732***
VULN 0.1990 −4.2037***
INDU 0.2534 −1.2921*
−.4265773***

−2.137845***

−1.265862***
Panel quantile regression estimates.

−3.3777 ***
7.990171***

.1013293***

2.150848***

READ 1.6759
(−288.36)
Quantiles

(-374.54)

Note: *** and * designate statistical significance at the 1% and 10% levels,
(−79.91)

(928.85)

(218.86)
(21.49)

respectively.
5th

Table 6
Panel cointegration test.
T-statistic p-value
Table 7

VULN
GDPG

READ

−7.988980
CBAL

INDU

ADF 0.000
INFL

Note: p-values designate statistical significance at the 1% level.

S90
N. Naifar
quantile coefficient estimates across seven quantiles τ = {0.05;
0.1; 0.25; 0.5; 0.75; 0.9; and 0.95}.
Table 7 indicates that the coefficients of GDPG (annual
percentage growth rate of GDP) and CBAL (current account
balance) negatively correlate with the SCDS spreads. Specif-
ically, the coefficients of these variables are negative, meaning
that an increase in GDPG and CBAL is associated with a
decrease in sovereign credit risk. GDPG is negatively related to
the SCDS spreads for all quantiles (except for the lower
quantiles Q = 0.10 and Q = 0.25). Generally, a higher GDPG
indicates a strong and expanding economy, which can improve
a country's ability to generate tax revenues, repay debt obli-
gations, and reduce the risk of default. As a result, an increase
in GDPG positively affects the perception of creditworthiness,
leading to lower SCDS spreads. In contrast, the CBAL mea-
sures a country's trade balance, indicating whether it is a net
exporter or importer of goods and services. A positive current
account balance is usually associated with a strong economy,
negatively affecting the SCDS spreads. However, when the
CBAL of a country deteriorates, it tends to have a detrimental
effect on the cost of insuring its sovereign debt.
Inflation (INFL) positively affects SCDS spreads across all
quantiles. The positive relationship between inflation and
SCDS spreads suggests that as inflation increases, the
perceived risk of default increases, resulting in higher SCDS
spreads. Inflation erodes the value of a country's currency,
making it more difficult for the government to service its debt
obligations and increasing the risk of default.
These findings are consistent with existing empirical
studies, such as Basurto et al. (2010), Augustin (2014), and
Cevik and Jalles (2022), which have also found a positive
relationship between inflation and SCDS spreads. The results
suggest that investors are sensitive to inflation when assessing a
sovereign borrower's creditworthiness and that higher inflation
levels increase the perceived risk of default.
The industrial production variable (INDU ) is negatively
related to the SCDS spreads only in the lower and median
quantiles, indicating that the increase in industrial production
strengthens a country's economy, decreasing a country's sov-
ereign credit risk. This finding is partly consistent with the
empirical study of Simonyan and Bayraktar (2022).
The empirical results suggest that climate change vulnerability
(VULN ) significantly impacts SCDS spreads. The positive and
significant relationship between VULN and SCDS spreads im-
plies that countries more vulnerable to climate change are
perceived as having a higher risk of default. That is, VULN in-
creases the perceived risk of default by the sovereign issuer of the
bond, leading to a higher SCDS spread. The coefficient of VULN
ranges between 0.86 and 2.96, depending on the quantiles of
SCDS spreads. This finding suggests that the impact of VULN on
SCDS spreads varies across different levels of perceived risk. The
highest coefficient is observed in an upper quantile (Q = 0.75),
indicating a more significant impact of VULN in countries already
perceived as having a higher default risk. Overall, these results
suggest that VULN significantly influences the perceived risk of
default by sovereign issuers of bonds. This has implications for
the cost of borrowing for these countries and their ability to access
S91
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Borsa Istanbul Review 23-S1 (2023) S84–S95
financial markets. It also highlights the need for policymakers to
address the issue of VULN to reduce the risk of default and
maintain access to capital markets.
Additionally, we find that climate change readiness (READ)
harms the SCDS spread, and this relationship is significant
across all quantiles. The negative relationship between climate
change readiness and SCDS spreads implies that investors view
countries with greater climate change readiness as less risky.
The coefficient values reported indicate the magnitude of the
effect. Specifically, for every one unit increase in climate
change readiness, the SCDS spread decreases by a range of
−1.26 to −5.19 units, depending on the quantile. This suggests
that improving a country's climate change readiness by one unit
significantly reduces the country's risk premium. Moreover, the
relationship between climate change readiness and SCDS
spreads strengthens as the quantiles are increased, indicating a
more significant impact of climate change readiness on SCDS
spreads in the higher quantiles. Thus, investors are increasingly
rewarding countries with higher levels of climate change
readiness with lower risk premiums. Overall, these findings
suggest that climate change readiness is an important factor for
countries seeking to reduce their risk premium and improve
their creditworthiness in the eyes of investors.
6. Robustness check
Several methods are used to robustness check the empirical
results obtained from the panel quantile regression. For the first
method, we changed the bootstrapping statistics that involve
repeatedly drawing samples from the original datasets and then
estimating each sample's panel quantile regression model. We
changed the number of resampling data sets from 1000 to 2000
and 5,000, which helps test the stability of the results obtained
from the original sample and estimate the distribution of the
coefficients. The main conclusions related to climate change
readiness and vulnerability have not changed.3 For the second
method, we performed a sensitivity analysis of the results ob-
tained by varying the number of quantiles used. We estimated
the results using five quantiles τ = {0.05; 0.25; 0.5; 0.75; and
0.95} and nine quantiles τ = {0.10; 0.2; 0.30; 0.4; 0.50; 0.60;
0.70; 0.80; and 0.90. The results remain strong, and the main
conclusions about climate change remain unchanged.
The third robustness check method of the empirical findings
involves adopting alternative control variables expected to
significantly influence SCDS spreads. The variables account
for financial sustainability, typically measured by the ratio of
public debt to GDP, which gauges a nation's ability to manage
its debt in the long run. Another critical factor is the degree of
financial development, captured by the ratio of stock exchange
capitalization to GDP, shedding light on the maturity and depth
of a country's financial systems. The level of national economic
development, proxied by GDP per capita, offers insights into a
country's economic health and growth potential. Finally, the
quality of national institutions, marked by indicators such as
3
The results of estimations are available upon request.
N. Naifar _
Borsa Istanbul Review 23-S1 (2023) S84–S95

Control of Corruption, Government Effectiveness, and Political

−0.0953854***

−0.0546542***

Note. The SCDS is the dependent variable. The numbers in parentheses are the t-values. The asterisk (***) and (*) denote statistical significance at the 1% and 10%, respectively. VULN (Climate risk vulnerability),
READ (Climate risk readiness), CCOR (Control of Corruption), GOVE (Government Effectiveness), STAB (Political Stability and the Absence of Violence/Terrorism), DGDP (The ratio of public debt to GDP),
−1.090691***
0.4549086***

0.6426258***
0.054613***
−3.165183*
Stability, combined with the Absence of Violence/Terrorism,

1.11175*

(−28.81)

(−17.15)

(−18.59)
provides a holistic view of a nation's governance and socio-

(−1.72)

(25.69)

(17.55)

(16.11)
(1.82)
political climate, which can indirectly influence credit risk

95th
perceptions. Data are from the World Bank database. Table 8
illustrates the panel quantile regression variables.
The quantile coefficient estimates across seven quantiles τ =
{0.05; 0.1; 0.25; 0.5; 0.75; 0.9; are 0.95} are presented in Table 9.

−0.0904223***

−0.0263188***

−0.9923355***
Table 9 indicates that VULN positively and significantly

−1.683396***
0.8004691***

0.0468423***

0.3623236***

0.1981725***
impacts sovereign credit default swap spreads across all

(−1329.82)
(−101.09)

(−735.06)
(271.58)

(547.15)

(236.91)
quantiles. Positive coefficients across all quantiles suggest that

(71.68)
(43.80)
90th
as climate risk vulnerability increases, the perceived credit risk
of the country also increases. This relationship is consistent
across the distribution of SCDS, but the strength of the effect
varies. For example, at the quantile (Q = 0.05), a unit increase
in vulnerability leads to a 0.4263 increase in SCDS. At the

−0.0383465***

−0.0163879***
quantile (Q = 0.90), this effect is greater at 0.80. We observe

−2.007898***

−0.390214***
0.0256305***

0.3842145***
2.066578***

−0.197032
negative coefficients for all quantiles for climate change read-

(−29.15)
(−3.53)

(−6.51)

(−0.97)

(−5.92)
(11.40)
iness (READ), suggesting that the perceived credit risk de-

(8.34)
(6.95)
75th
creases as a country's readiness to handle climate risks
improves. The varying signs of READ coefficients across
quantiles imply that the impact of climate readiness on sover-
eign credit risk is more complex and may differ across the
distribution of credit risks.

−0.4775079***

−0.2247552***
−0.031219***
0.2389684***

0.0096322***

0.2002978***
Regarding the control variables, GGOVE (Government

−1.80788***

0.012675***
(−114.40)
Effectiveness) negatively correlates with SCDS spreads. A

(−86.08)

(−80.28)
(51.94)

(47.64)

(46.46)

(72.98)
negative coefficient indicates greater government effectiveness
(6.41)
50th

reduces credit risk, possibly due to increased confidence in that

country's governance. Similar results are obtained for MGDP
(Stock market capitalization to GDP), indicating that a larger
−0.0534712***

−0.0017433***

−0.0170127***

−0.0004463***

−0.4457113***

−0.0887002***

MGDP (The percentage of stock market capitalization to GDP) and GDPC (GDP per capita).
Table 8
Alternative control variables description. 0.1706876***
1.67132***

(−214.29)
(−41.92)

(−12.06)

(129.96)
(−6.19)

(−8.53)

Dependent variable

(39.15)
(52.53)
25th

SCDS The Sovereign Credit Default

Swap spreads
Climate change variables
VULN Vulnerability Index
READ Readiness Index
−0.5714726***

−0.0022988***

−0.2569315***
0.0016215***

0.0440436***

0.0484239***

Control variables
−0142994***
2.0917***

(−172.89)

(−202.53)

DGDP The ratio of public debt to

(−64.80)
(205.45)

(26.92)

(52.45)

(33.35)

(60.46)
Panel quantile regression estimates (Robustness Check).

GDP (Proxy of financial

10th

sustainability)
MGDP The ratio of stock market
capitalization to GDP (Proxy
of financial development)
GDPC The GDP per capita (Proxy of
national economic
−0.0171306***

−0.1752533***
−0.434075***

−0.121274***
0.4263056***

0.0048597***

0.0036284***

0.0473369***

development)
CCOR Control of Corruption (Proxy
(−329.64)

(−428.15)

(−159.75)
Quantiles

(-111.14)

(105.77)

of quality of national
(90.04)

(83.94)
(76.59)

institutions)
5th

GOVE Government Effectiveness

(Proxy of governance quality
of national institutions)
STAB Political Stability and the
Absence of Violence/
Table 9

MGDP
VULN

GOVE
CCOR

DGDP
READ

GDPC

Terrorism (Proxy of
STAB

Investment Climate)

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N. Naifar _
Borsa Istanbul Review 23-S1 (2023) S84–S95

stock market relative to the GDP is considered a sign of eco- such as policymakers, international investors, and governments
nomic strength or maturity, reducing perceived credit risk. The formulating sovereign debt plans. The results of this study
DGDP (ratio of public debt to GDP) is positively and signif- provide new insights for international investors seeking to
icantly correlated to SCDS spreads. A positive coefficient in- diversify their portfolios and hedge against climate-related risks.
dicates that as the debt to GDP ratio increases, the credit risk For policymakers, the results underscore the importance of
(as reflected by SCDS) increases. Regarding the GDPC and considering climate change readiness and vulnerability when
CCOR, we obtained different relationships across quantiles predicting and explaining sovereign credit spreads. To effec-
(sometimes counterintuitive). The varying signs of coefficients tively manage the effects of climate change on public finances,
across quantiles imply that the impact of the control of cor- policymakers should focus on enhancing structural readiness
ruption and GDPC on sovereign credit risk is more complex through investments, ensuring societal stability and robust
and may vary across the distribution of credit risks. institutional structures, and promoting social readiness.
To conclude, the findings of the variables VULN and READ Improving climate change readiness is imperative for
align closely with prior empirical results (Table 7). Such con- developing countries facing greater exposure to climate
sistency underscores the robustness of our empirical findings. change. Implementing economic diversification plans and
Not only do these findings validate our methodology, but they strategic management strategies can help mitigate the impacts
also lend additional weight to the impact of climate risk vari- of climate change on their economies and financial markets.
ables on sovereign credit risk. Despite variations in datasets, Additionally, international investors can reduce portfolio risk
the recurrence of these results affirms our empirical model's by including countries with high climate change readiness.
resilience and reliability. The empirical study analyzed the SCDS of 21 countries;
expanding the sample size would yield more comprehensive
7. Conclusions and recommendations insights into the heterogeneous relationship between sovereign
credit risk and climate change variables. Furthermore, extending
This paper fills a crucial research gap by examining the the sample period to include extreme weather events and long-
connection between climate science and sovereign credit risk. term climate change trends would provide a more comprehen-
By investigating the influence of climate change readiness and sive understanding of the asymmetric behavior of climate
vulnerability on sovereign credit risk for developing and change and its impact on SCDS spreads. Such extensions would
advanced countries, this study sheds light on the significant enhance our knowledge of the intricate dynamics between
impact of climate change on the cost of government borrowing. climate change and sovereign credit risk and contribute to more
The findings indicate that nations more susceptible to climate informed decision-making in the face of evolving climate
change experience higher sovereign credit risk, as evidenced challenges.
by higher SCDS spreads. Conversely, countries with greater
climate change readiness exhibit lower SCDS spreads. This Declaration of competing interest
relationship between climate change readiness and SCDS
spreads is particularly pronounced at higher quantiles. There is no conflict of interest.
Understanding the determinants of sovereign credit risk in
the context of climate change is crucial for various stakeholders,
Appendix.
Table A1
Correlation matrix
LGDP GDPG INFL CBAL DEBT INDU VULN READ
LGDP 1.0000
GDPG −0.0749 1.0000
INFL −0.1097 0.2085 1.0000
CBAL −0.0709 0.0143 −0.2097 1.0000
DEBT 0.3393 −0.3370 −0.2290 −0.2019 1.0000
VULN −0.2898 0.2818 0.2909 −0.1162 −0.1052 1.0000
INDU −0.3877 0.3566 0.0978 0.5189 −0.4460 0.6127 1.0000
READ 0.3467 −0.1786 −0.4582 0.2661 0.1788 −0.6971 −0.3074 1.0000

Table A2
The mean of the panel quantile regression variables
Australia Bahrain Brazil China Egypt France Indonesia Italy Japan Korea Mexico
SCDS 64.28 269.03 193.68 80.83 403.20 57.69 151.07 194.50 59.24 67.51 123.95
LGDP 27.95 24.21 28.36 29.98 26.37 28.62 27.57 28.34 29.29 28.01 27.80
GDPG 2.35 2.68 0.96 7.18 3.78 0.58 4.74 −0.57 0.69 2.97 1.70
INFL 2.00 1.55 5.59 2.57 11.84 1.06 4.49 1.05 0.42 1.61 3.91
CBAL −2.44 0.48 −2.78 1.86 −3.20 −0.81 −1.78 1.20 2.69 4.53 −1.25
(continued on next page)

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Borsa Istanbul Review 23-S1 (2023) S84–S95

Table A2 (continued )
Australia Bahrain Brazil China Egypt France Indonesia Italy Japan Korea Mexico
DEBT 36.52 68.07 73.41 45.43 83.15 95.78 27.75 132.84 230.40 38.90 41.37
VULN 0.319 0.452 0.399 0.400 0.440 0.310 0.456 0.324 0.379 0.383 0.415
INDU 24.84 43.85 20.12 42.01 36.02 17.53 40.96 21.35 28.03 33.97 31.39
READ 0.705 0.474 0.387 0.511 0.332 0.657 0.408 0.511 0.716 0.722 0.425
Morocco Norway Russia KSA Spain Sweden Turkey UAE UK USA
SCDS 163.84 17.52 187.28 94.26 154.62 22.45 253.93 77.11 38.66 19.14
LGDP 25.44 26.80 28.17 27.27 27.93 27.02 27.45 26.65 28.65 30.53
GDPG 4.03 1.26 1.61 2.78 −0.07 2.12 5.50 3.01 0.84 1.80
INFL 1.12 2.03 6.54 2.37 1.09 1.07 10.06 1.14 1.97 1.72
CBAL −4.81 8.04 3.53 7.82 0.91 4.46 −4.37 10.07 −3.84 −2.35
DEBT 62.26 36.75 13.65 11.91 95.70 39.77 32.11 21.60 85.99 106.90
VULN 0.381 0.254 0.347 0.408 0.301 0.296 0.350 0.375 0.297 0.331
INDU 25.81 32.17 29.89 52.13 20.61 22.34 27.59 48.53 17.98 18.72
READ 0.400 0.780 0.555 0.478 0.537 0.743 0.454 0.564 0.695 0.703
Note. The SCDS is expressed in this table in basis points.

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