Working Paper

Climate Defaults and Financial Adaptation

Abstract: We analyze the relationship between climate-related disasters and sovereign debt crises using a model with capital accumulation, sovereign default, and disaster risk. We find that disaster risk and default risk together lead to slow post-disaster recovery and heightened borrowing costs. Calibrating the model to Mexico, we find that the increase in cyclone risk due to climate change leads to a welfare loss equivalent to a permanent 1% consumption drop. However, financial adaptation via catastrophe bonds and disaster insurance can reduce these losses by about 25%. Our study highlights the importance of financial frictions in analyzing climate change impacts.

Keywords: climate change; disasters; sovereign default; emerging markets; growth;

JEL Classification: Q54; F41; F44; H63; H87;

https://doi.org/10.21144/wp23-06

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2023-03

Number: 23-06