Extreme temperature and sovereign bond spreads: the role of state resilience

Purpose This paper aims to examine how extreme temperature anomalies – both observed and unexpected – affect sovereign borrowing costs across 81 countries from 2012 to 2023. It aims to quantify the short-term impact of climate shocks on sovereign bond spreads and to assess the mitigating role of institutional resilience. The study contributes to understanding the nexus between environmental risk, institutional capacity and public finance by highlighting how climate unpredictability and weak governance exacerbate sovereign risk pricing. Design/methodology/approach The authors use a monthly panel data set combining sovereign bond spreads, meteorological temperature data and institutional resilience indicators for 81 countries over 2012–2023. The empirical strategy applies panel regressions with robust specifications to estimate the effects of average and maximum temperature anomalies – both realized and unanticipated – on sovereign spreads. Threshold and subsample analyses are conducted to test heterogeneity by resilience level. Sensitivity checks ensure robustness of the findings. Findings Both realized and unanticipated extreme temperature anomalies significantly increase sovereign bond spreads, especially when temperatures exceed historical extremes. These effects are stronger in countries with weaker institutional resilience. Minimum temperature deviations and more predictable shocks have smaller impacts, suggesting adaptive capacity dampens market reactions. The results underscore that climate risk is priced into sovereign debt markets and that institutional quality mitigates these risks. Findings are robust across model specifications and subsamples. Research limitations/implications The analysis focuses on temperature-related climate risks and may not capture the full range of environmental hazards such as floods or droughts. Causal identification is constrained by observational data and the challenges of fully isolating exogenous shocks. Future research could explore long-term fiscal impacts, interactions with monetary policy and firm-level financial channels. The findings imply that sovereign risk models should better account for environmental risks and adaptive institutional capacities. Practical implications Policymakers should view climate adaptation as a financial stability priority. Strengthening institutions – particularly governance, revenue systems and public administration – can reduce sovereign borrowing costs and improve resilience. Credit rating agencies and debt sustainability frameworks should explicitly incorporate climate and institutional risk factors. Development agencies and international organizations can help vulnerable states by investing in climate governance and institutional strengthening, thereby reducing financial vulnerability and supporting sustainable development. Social implications Improving institutional resilience not only reduces fiscal stress but also protects social spending and public services during climate shocks. Stronger institutions help maintain stability, reduce inequality and foster trust in government responses to environmental crises. By integrating climate risks into sovereign financing and governance reforms, countries can better protect vulnerable populations and ensure social and economic sustainability in the face of increasing climate variability. Originality/value To the best of the authors’ knowledge, this study is among the first to quantify the differential effects of realized and unanticipated extreme temperature anomalies on sovereign spreads while explicitly accounting for institutional resilience. It contributes to the literature by linking climate unpredictability, governance quality and sovereign risk pricing using high-frequency, multi-country data. The findings highlight that financial markets increasingly respond to climate risks and that adaptive institutions play a critical role in mitigating such risks, offering valuable insights for policymakers, investors and development practitioners.