One of the most important issues in climate finance is whether climate risks are attracting investors’ attention and reasonably pricing in the financial markets. To address this issue, this paper takes drought risk, which is the most destructive and widely climate risk caused by climate change, as a proxy for climate risk and empirically examines its impact on the issuance pricing of local government bond. We find that drought risk significantly increases the credit spread and yield of local government bond, especially in the agriculturally dependent and less developed province. Mechanism analysis indicates that drought risk premium is embedded in issuance pricing through fiscal pressure intensification and investor climate awareness. Further research indicates that environmental actions committed to improving water resources, such as local water conservancy construction and the South-to-North Water Diversion Project, can mitigate investors’ negative concerns about future climate risks, thereby reducing the drought risk premium in local government bond. Overall, climate risks have become one of the important factors affecting the issuance pricing of local government bond, and environmental actions committed to improving water resources restrain the rise in financing costs caused by climate risks.