The Rising Tide Lifts Some Interest Rates: Climate Change, Natural Disasters, and Loan Pricing

Banks price physical climate change-related risks after observing natural disas ters linked to climate change. We isolate this updating process by identifying loans to borrowers at risk of, but not-directly affected by, climate change-related disasters. Loan spreads for these borrowers spike in both primary and secondary markets following such disasters and banks adjust internal probabilities of default, consistent with higher perceived credit risk. However, we also find evidence of overreaction due to salience, as the change in spreads is short-lived and ampli fied by media attention. This salience is associated solely with climate change-re lated disasters and impacts investment decisions at bank-dependent firms.