The Rise of Climate Risks: Evidence from Expected Default Frequencies for Firms

8 July 2025

Banca d'Italia today publishes 'The Rise of Climate Risks: Evidence from Expected Default Frequencies for Firms'.

The paper investigates the relationship between climate transition risk and credit risk by analysing firms' carbon emissions and Moody's Expected Default Frequencies (EDFs). The results suggest that the Paris Agreement was a turning point in the relationship between emissions and credit risk: following the Agreement, the correlation between emission levels and EDFs became positive and statistically significant. By decomposing the EDFs into their core components, increased asset volatility is found to be the main channel through which transition risk affects credit risk for high-emissions companies. The analysis sheds light on the mechanisms linking climate transition risk to financial risk. The results are robust across different model specifications, control variables and geographic areas, and indicate that climate-related financial risks have become increasingly important for credit markets.