International climate agreements are one of the best known ways to coordinate climate actions among governments. However, they face a free-rider problem, where individual governments may not have sufficient incentives to contribute to emission reductions. This study, written by Mandeep Singh (ICBS Centre for Climate Finance & Investment and University of Sydney, Australia) and Konark Saxena (UNSW Business School, University of New South Wales) explores the role of investors in providing rewards to governments, via sovereign bond yields, for encouraging climate cooperation and reducing emission intensity in their countries. Using a difference-in-differences method, this study examines how sovereign bond yields change around the finalisation of two landmark climate agreements: the Kyoto Protocol and the Paris Agreement.
The authors find that investors reward governments that commit to reducing greenhouse gas emissions under the Kyoto Protocol with a decrease in their sovereign bond yield of about 14 basis points. Around the Paris Agreement, investors reward countries with relatively higher emission intensities with a yield reduction of 3 basis points. The results are consistent with investors better compensating participating countries that make more significant commitments to join a climate agreement. Overall, findings suggest that some investors are carefully designing incentives to nudge governments towards addressing climate change effectively, shedding light on an interesting channel to help mitigate the free rider problem faced by climate agreements.
This Draft: November 21, 2023
First Draft: February 2022