Quentin Moreau, Hong Kong University of Science & Technology
Abstract: This paper develops a novel market-based framework to study the first and second-round effects of tail climate risks in the financial sector. Our framework identifies the financial institutions most vulnerable to physical and transition climate risks and tests whether climate risks can generate contagion effects within the financial sector. Based on the securities of large European financial institutions from 2005 to 2022, we show that, unlike physical risks, transition risks significantly and increasingly influence systemic risk in the financial sector. The exposure to transition risks appears lower for financial institutions with cleaner investment and lending portfolios and with a long-term orientation, implying that regulators and financial institutions have levers to mitigate financial risks arising from climate change.
Ruimeng Hu, University of California-Santa Barbara
Joseph Huang, University of Pennsylvania
Abstract: We study the implications of model uncertainty in a climate-economics framework with three types of capital: “dirty” capital that produces carbon emissions when used for production, “clean” capital that generates no emissions but is initially less productive than dirty capital, and knowledge capital that increases with R&D investment and leads to technological innovation in green sector productivity. To solve our high-dimensional, non-linear model framework we implement a neural-network-based global solution method. We show there are first-order impacts of model uncertainty on optimal decisions and social valuations in our integrated climate-economic-innovation framework. Accounting for interconnected uncertaintyover climate dynamics, economic damages from climate change, and the arrival of a green technological change leads to substantial adjustments to investment in the different capital types in anticipation of technological change and the revelation of climate damage severity.
Abstract: We analyze the information content of a variance risk premia extracted from the weather derivatives contracts written on the local temperature of individual U.S. cities. We term this the Weather Variance Risk Premia (WVRP). By constructing the WVRP measure from the CME's weather futures and options contracts, we examine the role of weather variance risk on bond credit spreads of local corporations and municipalities. Our results indicate informativeness of weather derivatives market as a local risk factor priced in the bond returns of local corporations and municipalities. Our results are robust to controlling state level economic uncertainty measures.
Discussant: Grigory Vilkov, Frankfurt School of Finance and Management
