The public cost of extreme climate: Empirical evidence from China's Urban Investment bonds

Abstract

Extreme temperature can worsen the sustainability of government finance, and is a public cost that needs to be identified. In this paper, we estimate the impact of high temperatures on spreads of Urban Investment Bond (UIB) by dividing daily mean temperatures obtained from weather stations into ten temperature bins and calculating the number of days in a year that fall into different temperature bins and matching them with China's bond-level data of UIBs. We find that an increase in extreme temperatures results in a significant rise in the yield spreads of UIBs. This is because extreme temperatures weaken the guarantee capacity of local governments as well as increase their demand for financing through UIBs. A series of robustness verify the robustness of the results. In further analysis, we explore the effect of investors' attention, mitigation and adaptation measures, heterogeneity and predicts the long-term impacts of temperature change. This paper enriches the literature on the impacts of climate change on the public sector, on the pricing of municipal bonds, on the impacts of climate change on developing countries, and provides credible policy implications for bond management and fiscal sustainability of local governments.