Work

Understanding climate risk in Europe: Are transition and physical risk priced in equity and fixed-income markets?

Year: 2025

Type: article

Abstract: This study explores how climate-related risk factors influence the European equity and fixed-income markets. We examine the effect of specific physicalrisk drivers, including temperature fluctuations, drought, floods, wind, and wildfire risk, on both stocks and bonds. Additionally, we assess the impact of transition risk using two potential indicators: the log-returns of futures on European Carbon Allowances and a Transition Risk Index derived from credit default spreads. We also compare them to see if they carry the same information. Our findings reveal that climate risk variables have different effects on stocks and bonds, with stock returns appearing mostly unaffected by climate-related variables. In contrast, bond z-spreads show significant statistical relationships with both physical and transition climate risks. Physical risk, on average, rewards the green bonds in the sample, and penalizes the traditional bonds. As for transition risk, the two proxiesare shown to capture different types of information and to affect different bonds. This suggests that credit default swaps are pricing a transition risk that goes beyond carbon emissions.

Source: Journal of Empirical Finance

DOI: 10.1016/j.jempfin.2025.101672

Authors: Nicola Bartolini, Silvia Romagnoli, Amia Santini

Institution: University of Bologna

Language: English

Topic: Sustainable Finance and Green Bonds

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

SDG: Climate action

Open Access status: hybrid

Estimated APC paid: $2,940