Systemic risk effects of climate transition on financial stability

Abstract

We assess how climate transition risk, through its effects on asset prices, could impact financial stability. Using copula functions, we characterize the conditional distribution of financial firm returns under different climate-related market scenarios. We account for average and tail effects of climate transition scenarios on the value of financial firms using three systemic risk metrics: climate transition expected returns, climate transition value-at-risk, and climate transition expected shortfall. Empirical evidence indicates that European banks experience the highest systemic impacts from a disorderly transition, and that the cost of rescuing more risk-exposed financial firms from climate transition losses is relatively manageable.