Investors in government bonds reward countries for participating in climate agreements and committing to reduce emissions, according to a new study. The rewards are greatest for countries that face greater costs for participating, suggesting investors are nudging governments to address climate change in a systematic way.
International climate agreements can help the world take collective action to stop climate change, but face what’s known in economics as a “free-rider problem:” any individual country has an incentive not to sign on to such agreements, and let other countries do the hard work and bear the costs of reducing emissions.
“This novel finding offers hope for overcoming the free-rider problem in international climate cooperation, even within traditional cost-benefit frameworks,” study team member Konark Saxena, a finance professor at ESCP Business School in Paris, France, says of the new study.
The results echo other research suggesting that investors reward firms that take climate action and punish those that ignore climate change or have a negative impact on the climate. That pattern now seems to hold true for investments in countries, not just firms.
“Our paper reveals that investors recognize the benefits of government collaboration through climate agreements as outweighing the costs, such as stricter regulations,” Saxena says.
Saxena and his collaborator, Mandeep Singh of the University of Sydney in Australia, gathered data on 10-year monthly sovereign bond yields from an existing database of information from central banks. They compared sovereign bond yields for countries with high historical greenhouse gas emissions that either did or did not sign the Kyoto Protocol, before and after ratification. They also compared high- and low emissions countries before and after announcing national emissions reduction plans under the Paris Agreement.
Countries that participate in international climate agreements subsequently see a 4 to 5 basis point decrease in sovereign bond yields, the researchers report in the journal Nature Communications.
A decrease in bond yield reflects greater demand for government bonds from investors, and means that the government can raise more capital with a given bond, essentially increasing the government’s borrowing capacity.
“Frameworks like the Paris Agreement and Kyoto Protocol help align national incentives with international efforts, making what is rational for individual countries more consistent with global climate goals,” Saxena says.
The decrease in sovereign bond yield is especially pronounced for countries that have more emissions-intense economies, larger populations, and less physical exposure to climate change risk (in the form of relatively few people living near the coast and therefore vulnerable to sea level rise). Such countries bear higher costs of participating in climate agreements or have less intrinsic incentive to do so.
“We were surprised by how consistently investors rewarded those bearing the greatest costs of cooperation, as we initially were unsure whether they would perceive the benefits of climate cooperation as outweighing the costs,” says Saxena.
The result is a promising sign about the potential for markets to address the free-rider problem, Saxena says. “We hope it encourages investors and policymakers to design incentives that promote climate cooperation rather than relying solely on punitive measures for high-emission countries and firms.”
Saxena and his collaborators are working on additional investigations of how investment portfolios can be structured to balance climate action and clients’ financial goals, as well as how governments can best make use of investments that encourage climate cooperation, he reports.
Source: Saxena K. and M. Singh. “Investors reward countries for participating in climate agreements.” Nature Communications 2024.
Image: by @Iftikhar Alam/Freepik
