Don’t Lead Me This Way: Central Bank Guidance at the Age of Climate Change

Using Natural Language Processing under the form of topic modelling, we are able to extract a specific topic labeled ”Climate Change” from ECB communication on the period 1997-2021. We found an exponential increase of the presence of this topic in ECB communication since mid-2018. The analysis of the terms employed in ECB speeches on this topic provides evidence that the ECB talks about climate change as a source of risk for financial markets, leading financial actors to expect a potential regulatory risk from the ECB. Second, we use our findings from this first study and show that an increase in ECB communication about climate change leads to an overall increase in 168 North-American firms’ probability of default proxied by their Credit Default Swaps spread returns. Moreover, we provide evidence of a nonlinear effect of ECB communication about climate change on CDS spread returns, with significant and negative estimated coefficients in the short-term, non-significant ones in medium term and strongly significant and positive estimated coefficients on the long term. Finally, our results suggest that the market recognizes which sectors are better positioned for a transition to a low-carbon economy.