We analyze the relationship between climate-related disasters and sovereign debt crises using a model with capital dault risk together lead to slow post-disaster recovery and heightened borrowing costs. Calibrating the model to Mexico, we find that the increase in cyclone risk due to climate change leads to a welfare loss equivalent to a permanent 0.95% consumption drop. However, financial adaptation via catastrophe bonds and disaster insurance can reduce these losses by about 21%. Our study highlights the importance of financial frictions in analyzing climate change impacts. […]