Climate-linked bonds as a catalyst for the green transition

This policy brief examines climate-linked bonds as an innovative financial instrument for managing and mitigating climate risks. These bonds can be issued by governments or supranational organizations to enhance market completeness and facilitate climate risk pricing and trading. Climate-linked bonds are designed so that their payouts are linked to the realization of specific climate variables, such as average land temperature or atmospheric greenhouse gas concentrations. These bonds thereby ensure that governments have a direct fiscal incentive to accelerate the green transition. Climate-linked bonds also make explicit the government’s implicit role as the ultimate insurer of long-term climate risks. The welfare benefits of the bonds arise because economic agents face climate risks asymmetrically, allowing for more efficient risk distribution in an economy through trading.