Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico
IMF Working Papers, August 25, 2023
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- Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico
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Bibliographic details
- Authors: Dimitrios Laliotis, Sujan Lamichhane
- Published: August 25, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400252433.001
Summary and objective
- Authors: Dimitrios Laliotis, Sujan Lamichhane
- Date: August 25, 2023
- Objective: Develop a novel forward-looking approach to study the financial stability implications of climate-related transition risks using an integrated micro-macro framework and a new class of scenario called delayed-uncertain pathways.
Methodology and modeling features
- Integrated micro-macro framework with "delayed-uncertain pathways" scenario class.
- Additional stochastic financial modeling layer via a jump-diffusion process to:
- Capture continuously changing risks.
- Capture the potential of large/sudden shocks in the financial markets.
- Application: Transition risks studied for the Mexican financial sector; framework described as easily adaptable to other countries.
- Outputs: Projections of future distributions of various risk metrics to quantify evolving tail risks arising from compounding effects of transition delays and policy-path uncertainty.
Key findings and projections
- The longer the delays in transition, the larger the future tail financial risks.
- These increased tail financial risks could be material to the overall system.
- The study quantifies projections of future distributions of various risk metrics and the evolving tail risks (no numerical projections provided on the landing page beyond study descriptors).
Scope, subjects, and keywords
- Subject: Climate change, Credit risk, Environment, Financial regulation and supervision
- Keywords: Climate change, Credit risk, default risk, financial stability, Global, greenhouse gas emissions, jump-diffusion, mapping CGE model sector, NAICS sector classification, probabilities of default, stress testing, tail risk, transition risk, vulnerability indicator
Implications for policy and practice
- Delays in transitioning to a low-carbon economy increase and compound financial tail risks, implying that timely transition and clearer policy paths can reduce future systemic tail risk.
- The framework is adaptable and can inform country-specific analyses of transition risk and financial stability stress testing.
Source: Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico (IMF Working Paper No. 2023/175).
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- Working Paper