The impact of carbon emissions on country risk: evidence from the G7 economies

Abstract

This paper empirically investigates the effect of carbon emissions on sovereign risk? To answer this question, we use fixed effects model by using annual data from G7 advanced economies, which includes Canada, France, Germany, Italy, Japan, UK and USA, for the period from 1996 to 2014. We employ a novel extreme value theory to measure sovereign risk. The results indicate that climate change (carbon emissions) are likely to increase sovereign risk significantly. We also expand our analysis to some specific sectors, as some of the sectors emit more carbon than others. Specifically, we take top three polluting sectors namely: transportation, electricity and industry and show that they are more likely to increase the sovereign risk. Our results are robust to change in risk measures, estimation in differences and dynamic version of econometric models. Therefore, we have robust consideration that the carbon emissions significantly explain the sovereign risk.