Title: The climate spread of corporate and sovereign bonds

Abstract: Climate risk brings about a new type of financial risk that standard approaches to risk management are not adequate to handle. Amidst the growing concern about climate change, central banks, financial regulators and policy makers are concerned with the risk of a disorderly low-carbon transition, i.e. a situation in which a sudden introduction of climate policy (e.g. a carbon tax) cannot be fully anticipated by investors and affects large portions of assets, causing asset price volatility (both positive and negative). We develop a model that allows to compute the valuation adjustment of corporate and sovereign bonds conditioned to climate transition risk, based on available forward-looking knowledge on climate policy scenarios provided by climate economic models. Our model allows to investigate the impact of the endogeneity and deep uncertainty of future scenarios on both the valuation of individual bonds and on standard risk metrics for a leveraged investors, considering the role of fossil fuels and carbon intensive activities in the economy of countries. We investigate the sensitivity of investor's Expected Shortfall and PD on key parameters. Policy implications from our result include that Climate stress test exercises should allow for a wide enough sets of scenarios to avoid underestimation of losses. (joint work with Irene Monasterolo)