Extreme weather events, exacerbated by climate change, have had significant impacts on the economy, highlighting the pressing need to address the transmission of physical climate risks to financial markets. In this paper, we assess the impact of extreme rainfall risk on bond spreads by leveraging county-level precipitation and urban investment bonds in China. Our findings suggest that a one-day increase in the frequency of extreme rainfall in the previous year results in an increase of bond spreads by approximately 3 basis points. Notably, while adaptation bonds effectively reduce the adverse impact of extreme rainfall on local financing costs, we find no evidence that extreme rainfall risk influences the issuance behavior of local bonds. Furthermore, interventions by higher-level authorities can mitigate these impacts. This paper contributes to the literature by clarifying how climate risks are integrated into bond market pricing and underscores the importance of adaptive financial instruments in managing physical climate risks.

About the speaker

Yangsiyu Lu is an assistant professor at Hong Kong University of Science and Technology (Guangzhou) and a research associate with University of Oxford’s Institute for New Economic Thinking. She was a DPhil researcher in the Economics of Sustainability group at INET. Before joining HKUST, she worked as a research fellow at Paris School of Economics and Boston University. Her multi-disciplinary research focuses on energy, climate and the environment. She is particularly interested in three areas: 1) Transition of fossil fuel assets, 2) Investment in clean technologies, and 3) Management of transitional risks. She holds a DPhil degree specialised in Environmental Economics from the University of Oxford, a master’s degree in Energy and Environment from IMT Mines Albi, and a bachelor’s degree in Environmental Science and Engineering from Shanghai Jiao Tong University.