CO₂ emissions per capita are positively correlated with 10-year sovereign bond yields. This is the key finding from the study "Decoding climate-related risks in sovereign bond pricing: a global perspective", July 2025, published by the Bank for International Settlements, authored by Sofia Anyfantaki, Marianna Blix Grimaldi, Carlos Madeira, Simona Malovana, and Georgios Papadopoulos.
The paper provides an in-depth analysis of the relationship between climate risk and sovereign bond yields, offering a novel global perspective. The study examines 52 economies (both developed and emerging) from 2000 to 2023, aiming to decode how climate risks—both physical and transition-related—are reflected in government financing costs.
Transition Risk: Higher Emissions, Higher Yields
The main result of the study is clear: CO₂ emissions per capita are positively correlated with 10-year sovereign bond yields, particularly in emerging economies and high-emission countries, especially after the 2015 Paris Agreement. According to the authors, this reflects the growing recognition by investors of the economic and fiscal risks associated with unmanaged climate transition.
Physical Risks: Chronic and Acute, but Less Priced In
Unlike transition risks, chronic physical risks (such as the gradual increase in average temperatures) do not appear to systematically influence sovereign bond yields. Acute climate shocks (such as climate-related natural disasters) have limited long-term impact but become more relevant in the medium term, particularly in developing countries with high public debt.
Among disasters, droughts are the most financially destabilizing, followed by storms and heatwaves, with more intense effects in poorer countries with limited fiscal capacity.
The Importance of Fiscal Capacity
The study highlights that the level of public debt is a key factor in the transmission of climate risk. In countries with high debt, natural disasters tend to result in greater increases in sovereign yields, signaling fiscal vulnerability. Conversely, countries with fiscal space are better able to absorb shocks without immediate penalties on debt costs.
Implications for Policy and Finance
The findings offer crucial insights for policymakers and investors:
- Climate transition already affects the cost of sovereign debt, making the adoption of credible environmental policies increasingly urgent.
- Climate risks are asymmetric, hitting low-income and environmentally exposed countries the hardest.
- There is a need to integrate climate risk into sovereign debt management and macroeconomic surveillance, especially to avoid a vicious cycle of climate disasters, rising debt, and higher borrowing costs.
Conclusion
The study shows that markets are beginning to price in climate risk—at least in its more tangible components. But it also highlights a significant underestimation of chronic physical risk, which could pose a latent threat to financial stability. Global sovereign finance must prepare for a future in which climate becomes a structural determinant of country risk.
