A Finance Approach to Climate Stress Testing
51 Pages Posted: 6 May 2020
Date Written: April 10, 2020
There is increasing interest in assessing the impact of climate policies on the value of financial sector assets, and consequently on financial stability. Prior studies either take a “black box” macro-modelling approach to climate stress testing or focus solely on equity instruments – though banks’ exposures predominantly consist of debt. We take a more tractable finance (valuation) approach at the industry-level and use a Merton contingent claims model to assess the impact of a carbon tax shock on the market value of corporate debt and residential mortgages. We calibrate the model using detailed, proprietary exposure data for the Dutch banking sector. For a €100 to €200 per tonne carbon tax we find a substantial decline in the market value of banks’ assets equivalent to 4-63% of core capital, depending on policy choices.
Keywords: Climate stress test, contingent claims analysis, climate policies, carbon tax, banks
JEL Classification: G13, G21, H23, Q54
Suggested Citation: Suggested Citation