Are municipal bonds affected by environmental risks?
Marcus Painter's study An Inconvenient Cost: The Effects of Climate Change on Municipal Bonds explores the financial implications of climate change risks for the municipal bond market.
He focuses on how investors price the long-term risks associated with climate change, particularly in coastal areas expected to be affected by sea level rise.
His main conclusions include:
- Counties more likely to be affected by climate change, particularly due to sea level rise, face higher underwriting fees and initial yields when issuing long-term municipal bonds.
- A 1% increase in climate risk leads to a 23.4 basis point increase in annualised issuance costs for long-term bonds.
- There is no significant difference in issuance costs between climate-affected and non-climate-affected counties for short-term municipal bonds.
- The difference in issuance costs between climate-affected and non-climate-affected counties increases after significant climate change reports are released.
- The increased issuance costs are more pronounced for bonds with lower credit ratings, highlighting that poorer-rated municipalities are perceived as more vulnerable to climate change risks.
The study suggests the market prices climate change risks primarily in long-term securities and that investors' attention to climate risks can influence bond pricing.
The study may be criticised for its focus on sea level rise might not capture other climate-related risks, such as hurricanes or droughts, that could also affect municipal bond markets.