On the Dependence of Investor’s Probability of Default on Climate Transition Scenarios

25 Pages Posted: 9 Mar 2021

See all articles by Stefano Battiston

Stefano Battiston

University of Zurich - Department of Banking and Finance; Ca Foscari University of Venice

Irene Monasterolo

Boston University; Vienna University of Economics and Business

Date Written: December 6, 2020

Abstract

Climate risk brings about a new type of financial risk that standard approaches to risk management are not adequate to handle. Amidst the growing concern about climate change, financial supervisors and risk managers are concerned with the risk of a disorderly low-carbon transition. We develop a model to compute i) the valuation adjustment of corporate bonds, depending both on climate transition risk scenarios and on companies’ shares of revenues across low/high-carbon activities, and ii) the corresponding adjustments of an investor’s Expected Shortfall and probability of default. Implications for central banks' climate financial risk management include that climate stress test exercises should allow for a wide enough set of scenarios in order to limit the underestimation of losses.

Keywords: Climate transition risk, climate policy scenarios, probability of default, corporate bonds, Expected Shortfall, climate financial risk assessment, risk management

JEL Classification: G10, G32, Q54

Suggested Citation

Battiston, Stefano and Monasterolo, Irene, On the Dependence of Investor’s Probability of Default on Climate Transition Scenarios (December 6, 2020). Available at SSRN: https://ssrn.com/abstract=3743647 or http://dx.doi.org/10.2139/ssrn.3743647

Stefano Battiston (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Andreasstrasse 15
Zürich, 8050
Switzerland

Ca Foscari University of Venice ( email )

Cannaregio 873
Venice, 30121
Italy

Irene Monasterolo

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

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