CGSRTSRIR

• Ref.: PID2025-169228NB-I00
• Principal Investigator: Santiago Forte Arcos 
• Funding body: MCIU-FEDER
• Duration: 36 months
• Period: September 2026 – August 2029

This project contains three main objectives. The first is to analyze the limitations of traditional measures of the return on risky debt and its spread over risk-free interest rates. The second is to employ adequate long-term credit risk measures to investigate how geopolitical risk and climate risk affect the credit risk of sovereigns and corporates in the long run. The third and last main objective is to analyze how temporal fluctuations in ESG performance affect firms cost of financing. These general objectives comprise in turn into four specific objectives:

1. The TSIR, or zero-coupon yield curve, reflects the return on risk-free debt as a function of the maturity date. It is commonly assumed that, in the case of risky debt, there exists an equivalent curve (RTSIR), and that the spread between the two is an appropriate measure of default risk. Although both curves can be mathematically estimated using identical procedures, the economic interpretation of the RTSIR is hindered by the fact that, unlike risk-free debt, risky debt does not have a defined set of possible payments. Thus, we will delve into the economic interpretation of the RTSIR and propose economically meaningful alternatives.

2. We will investigate the nonlinear and dynamic nature of geopolitical risk in sovereign debt markets. To this end, we will examine the relationship between available geopolitical risk indices and the cost of sovereign debt, the latter measured using credit default swap (CDS) spreads for both spot and forward contracts. We will introduce a novel approach that captures the evolving and intensity-dependent (tail-risk) nature of this relationship, thereby overcoming the limitations of the static and linear specification that is common in the existing literature.

3. The assessment of climate change effects on individual firms is multifaceted and companies are exposed to both the direct effects of climate-related natural disasters (physical risk) and the effects of transition to a low-carbon economy (transition risks). Thus, it is expected that investors incorporate climate related risks ex-ante in the prices of financial assets, especially those with longer maturities, such as CDSs. We will analyze to what extent firms exposure and vulnerability to physical climate hazards affects ex-ante their long-term credit risk and what is the term structure of the climate risk impact incorporated in the forward credit spread curve.

4. We will analyze how firms daily ESG performance fluctuations, captured through ESG volatility, influence their financing costs. We will employ a firmspecific measure that incorporates both positive and negative ESG signals to provide a more comprehensive assessment of ESG performance dynamics. Specifically, we will examine how this ESG volatility relates to the implied cost of equity derived from analysts forecasts, as well as the potential for firms to lower financing costs by adopting long-term, consistent sustainability strategies.