Surging Sovereign Spreads: The Impact of Coastal Flooding on Sovereign Risk


Coastal flooding, exacerbated by sea level rise, is a considerable economic threat to low-lying regions. I investigate whether investors account and insure for this hazard by exploiting the heterogeneity of country exposure to current and future coastal floods. Using sovereign credit default swap (CDS) spreads as premiums that incorporate information on credit quality and insurance demand, I document that severe coastal surge disasters increase the credit risk of affected countries across contract maturities. For a sample of 13 countries most vulnerable to short-term coastal flooding, I find a positive and significant relationship of sovereign risk to global and local attention toward physical and adaptation risks. In contrast, investors do not account for adverse future trends of flooding under climate model projections of sea levels, land subsidence, and population growth. Countries that have built protection against 1-in-100 year floods experience no increase in sovereign risk during periods of increased attention to adaptation risk. Additional tests demonstrate a positive and significant relationship between sovereign CDS trading and attention, explicitly revealing that investors purchase insurance against countries with existing flood exposure. The results suggest that sovereign risk will rise with the perception of coastal flooding, leading to increased financial pressures for exposed countries.

Available at SSRN 4058301