Does climate risk necessarily raise sovereign default risk? While a growing literature documents adverse effects from realized disasters, the implications of long-term (chronic) climate risk remain unclear. Using an endogenous default model with climate shocks, we isolate chronic physical risk from acute disaster realizations. We show that higher climate risk can increase sovereign bond prices by reducing default incentives. Risk-averse governments value continued market access as insurance against future shocks, strengthening repayment motives. While acute disasters still depress prices on impact, chronic risk can operate through a precautionary channel.
Balzer et al. (Mon,) studied this question.