Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico

August 25, 2023

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Format: Chicago

Dimitrios Laliotis, and Sujan Lamichhane. Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico, (USA: International Monetary Fund, 2023) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper explores a novel forward-looking approach to study the financial stability implications of climate-related transition risks. We develop an integrated micro-macro framework with a new class of scenario called delayed-uncertain pathways. An additional stochastic financial modeling layer via a jump-diffusion process is considered to capture continuously changing risks, as well as the potential of large/sudden shocks in the financial markets. We applied this approach to study transition risks in the Mexican financial sector. But the implications are global in scope, and the framework is easily adaptable to other countries. We quantify the projections of future distributions of various risk metrics and, hence, the evolving tail risks due to compounding effects from delays in transitioning to a low-carbon economy and the consequent uncertainty of the future policy path. We find that the longer the delays in transition, the larger the future tail financial risks, which could be material to the overall system.

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

Publication Details

Pages:

36
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/175
Stock No:

WPIEA2023175
ISBN:

9798400252433
ISSN:

1018-5941

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