## Default Risk and Transition Dynamics with Carbon Shocks

_IMF Working Papers, August 25, 2023_

## Source details

**Canonical URL:** [Default Risk and Transition Dynamics with Carbon Shocks](https://www.imf.org/en/publications/wp/issues/2023/08/25/default-risk-and-transition-dynamics-with-carbon-shocks-537993)

## Other formats

- [Markdown version](/en/publications/wp/issues/2023/08/25/default-risk-and-transition-dynamics-with-carbon-shocks-537993/index.md)
- [Structured JSON version](/en/publications/wp/issues/2023/08/25/default-risk-and-transition-dynamics-with-carbon-shocks-537993/index.json)
- [Bundle manifest](/en/publications/wp/issues/2023/08/25/default-risk-and-transition-dynamics-with-carbon-shocks-537993/bundle-manifest.json)

## Bibliographic details
- Authors: Sujan Lamichhane
- Published: August 25, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400252440.001

---

### Research question and approach
- Develops a continuous time heterogeneous agents model to study the impact of carbon pricing policy shocks on corporate default risk and the consequent transition dynamics.
- Derives a closed-form solution to corporate default probability based on firms' intertemporal optimization decisions.
- Explicitly characterizes the transition speed, enabling analytically tractable study of policy implications.

### Key findings
- Carbon-intensive sectors face increased default risks.
- There are notable asymmetric effects within sectors.
- Higher carbon prices increase default risk but also induce faster transition towards the new post-shock steady state with a highly non-linear impact.
- Once a range of possible price shocks are accounted for, the increase in the cost of capital/risk premiums might be sharply different across sectors.

### Calibration and scope
- The model is calibrated to different US corporate sectors to quantify the heterogeneous effects of carbon price shocks.

### Policy implications and analytical contributions
- Provides an analytically tractable framework for assessing how carbon pricing policy shocks propagate to corporate default probabilities and transition dynamics.
- Highlights that the same carbon price shock can have sharply different implications for cost of capital/risk premiums across sectors because of heterogeneity and non-linear transition dynamics.

### Publication and metadata
- By Sujan Lamichhane
- August 25, 2023
- Pages: 51
- Volume: 2023
- Issue: 174
- Series: Working Paper No. 2023/174
- DOI: https://doi.org/10.5089/9798400252440.001
- Stock No: WPIEA2023174
- ISBN: 9798400252440
- ISSN: 1018-5941
- Subject: Debt default, Economic sectors, Environment, External debt, Greenhouse gas emissions, Manufacturing
- Keywords: carbon price, carbon price shock, climate mitigation policy, climate risk, cost of capital, Debt default, default rate, Default risk, Global, Greenhouse gas emissions, Manufacturing, policy shock, price shock, risk premium., transition dynamics

*Source: IMF Working Papers — "Default Risk and Transition Dynamics with Carbon Shocks" by Sujan Lamichhane, August 25, 2023.*

---

## Content in this bundle

- **Working Paper**
  - [Working Paper (Markdown version)](/-/media/files/publications/wp/2023/english/wpiea2023174-print-pdf.pdf.md){rel="alternate" type="text/markdown"}
  - [Working Paper (PDF)](/-/media/files/publications/wp/2023/english/wpiea2023174-print-pdf.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2023/08/25/default-risk-and-transition-dynamics-with-carbon-shocks-537993_