Wildfire risk and municipal bond yields

Abstract Wildfires increased in frequency and severity over the past 30 years, raising the exposure of municipalities. We study whether municipal bond yields reflect wildfire risk and find that the municipal bond market begins pricing wildfire risk around 2000. A one‐standard‐deviation rise in wildfire risk leads to a 3.646 basis points increase in a bond's yield spread, increasing financing cost for affected communities. The effect on yield spreads disappears for maturities of less than 1 year or more than 15 years, supporting the view that wildfire risk is a medium‐term risk. When including measures of investor attention into our analysis, we find that investor attention is associated with an additional increase in yield spreads. Fire mitigation measures, on the other hand, are associated with a reduction in yield spreads, highlighting the benefits of wildfire risk management for municipal financing.