Environmental performance and sovereign bond yields: Evidence from emerging markets

Sammanfattning: This thesis analyses if investors price a country’s environmental (E) performance into sovereign bond yields. The sample consists of 17 emerging countries from 2011 to 2020. Environmental performance is measured by aggregating 12 metrics from World Bank’s Environmental, Social & Governance database to a single index using principal component analysis. The panel data model combines the E index and the usual macro-financial metrics key to assessing sovereign risk. The results show that environmental aspects also determine the level of compensation. This means that in addition to keeping a country’s financials in line, extra-financial performance is crucial as well. Moreover, the magnitude of the index is only behind the first lag of the yield and the currency premium and is higher than S&P’s credit ratings’ coefficient. The result remains robust after altering the composition of the E index, controlling for the exchange rate, and adding the Human Development Index.