Investors reward countries for participating in climate agreements.

Abstract

International climate agreements are one of the best-known approaches to coordinating climate actions among governments but face a free-rider problem, where individual governments lack sufficient incentives to reduce emissions. This study examines the role of investors in providing rewards to governments through sovereign bond yields to encourage climate cooperation and reduce emission intensity. Using a difference-in-differences method, this study examines how sovereign bond yields change around the Kyoto Protocol and the Paris Agreement. The findings show that investors reward governments committed to reducing greenhouse gas emissions with a 4 to 5 basis point decrease in sovereign bond yields. This suggests that investors better compensate countries making significant commitments to climate agreements, helping mitigate the free-rider problem and encouraging effective climate action.