Extreme Temperatures and the Cost of Public Debt: Evidence from China

Climate risk is priced by investors in the municipal bond market and is reflected in government financing costs that need to be identified. Based on theoretical analysis, this paper matches project-level data on local government special bonds (LGSBs) issued by Chinese local governments between 2018 and 2021 with city-level meteorological data to empirically evaluate the impact of extreme temperatures on issuance spreads for these bonds. The empirical results show that extreme high temperatures increase the spreads of LGSBs. The mechanism is that extreme heat weakens expected project return prospects and decreases government fund revenues. This paper reveals the climate risk factors implicit in the price formation of local government bonds in China, highlighting the importance of incorporating climate risks into fiscal decision-making frameworks.