The Case for Climate Linkers

We make the case for sovereign climate-linked bonds (CLBs), long-dated debt instruments whose payments depend on an observable climate index. Unlike green bonds, CLBs transfer climate risk rather than earmark funds, and their prices could provide market-based measures of expected climate outcomes. Issuing them confronts governments with a central trade-off: investors may pay an insurance premium for bonds that perform well in adverse climate states, lowering expected financing costs, but the same payoff raises debt service when climate damages may already weaken public finances. In an illustrative frictionless calibration, the financing benefit and the fiscal-risk cost of this additional exposure are of similar magnitude, leaving only a small net benefit before accounting for information. Modest informational gains are therefore material, but small implementation costs can overturn the result.