Natural Disasters, Adaptation and Default Risk

This paper studies how sovereign default risk shapes public investment in climate adaptation. We build a sovereign default model in which governments invest in adaptation to reduce disaster damages. Sovereign risk depresses adaptation through two mechanisms: higher borrowing costs and debt overhang under long-term debt. These effects generate feedback between risk and disaster exposure. Using a new panel of adaptation spending from budget records, we show that after catastrophic disasters spreads rise where prior adaptation was low, and that losses are smaller where adaptation
budgets recently increased. In our calibration, adaptation yields the largest welfare gains near the default boundary, where financing is tightest.