Is drought risk priced in private debt contracts?

We investigate whether banks price drought risk in the interest rates charged to corporate borrowers. The results show that banks do charge drought‐affected borrowers higher loan spreads. The spread increase is most pronounced among food industry borrowers. Our findings are robust to alternative dro...

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Bibliographic Details
Published in:International review of finance 2021-06, Vol.21 (2), p.724-737
Main Authors: Do, Viet, Nguyen, Thu Ha, Truong, Cameron, Vu, Tram
Format: Article
Language:English
Subjects:
Bank loans
Drought
drought risk
food industry
lending experience
loan spreads
Risk premiums
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Summary:We investigate whether banks price drought risk in the interest rates charged to corporate borrowers. The results show that banks do charge drought‐affected borrowers higher loan spreads. The spread increase is most pronounced among food industry borrowers. Our findings are robust to alternative drought measures. We also document that lenders with more experience in lending to drought‐affected food borrowers charge a lower drought risk premium, and borrowers' credit rating of investment grade can act as a mitigating factor on drought risk effects. Our study highlights that externalities from local weather shocks are relevant to the private debt market.
ISSN:1369-412X
1468-2443
DOI:10.1111/irfi.12294