Climate, Race, and the Cost of Capital in the Municipal Bond Market

Both climate risk and race are factors that may affect municipal bond yields, yet each has received relatively limited empirical research attention. The authors analyzed >712,000 municipal bonds representing nearly 2 trillion USD in par outstanding, focusing on credit spread or the difference between a debt issuer’s interest cost to borrow and a benchmark “risk-free” municipal rate. The relationship between credit spread and physical climate risk is significant and slightly positive, yet the coefficient indicates no meaningful spread penalty for increased physical climate risk. We also find that racial composition (the percent of a community that is Black) explains a statistically significant and meaningful portion of municipal credit spreads, even after controlling for a variety of variables in domains such as geographic location of issuer, bond structure (e.g., bond maturity), credit rating, and non-race economic variables (e.g., per capita income). Our combined findings indicate a systemic mispricing of risk in the municipal bond market, where race impacts the cost of capital, and climate does not.