1,721,135 research outputs found
Over with carbon? Investors’ reaction to the Paris Agreement and the US withdrawal
Full text linkHow financial investors may react to policy events related to sustainability and climate change mitigation in particular, is a key question with implications for sustainable finance and financial stability. We address this question by carrying out a multi-period difference-in-difference approach on a confidential database of securities holdings of the European Central Bank, and we provide evidence of several effects related to the Paris Agreement. In aggregate, investors reduced their participation in the equities of high-carbon firms in response to the agreement, and the trend reverted after the US’s announcement of withdrawal from the agreement. However, the reaction varies across categories and geographies of the securities holders, their ownership size, and the emissions of owned firms. In particular, transition risk has been taken up by less regulated financial institutions and the BRIC countries. Our results highlight that the redirection of global financial flows towards climate action requires clear and unanimous signals from the global community of policy makers
Climate risks and financial stability
Full text linkClimate change has been recently recognised as a new source of risk for the financial system. Over the last years, several central banks and financial supervisors have recommended investors and financial institutions to assess their exposure to climate-related financial risks. Central banks and financial supervisors have also started to design scenarios for climate stress tests - to- assess how vulnerable the financial system is to climate change. Nevertheless, the financial community falls short of methodologies that allow the successful analysis of the risks that climate change poses to financial stability. Indeed, the characteristics of climate risks (i.e., deep uncertainty, non-linearity and endogeneity) challenge traditional approaches to macroeconomic and financial risk analysis. Embedding climate change in macroeconomic and financial analysis using innovative perspectives is fundamental for a comprehensive understanding of the macrofinancial relevance of climate change. This Special Issue is devoted to the relation between climate risks and financial stability and represents the first comprehensive attempt to fill methodological gaps in this area and to shed light on the financial implications of climate change. It includes original contributions that use a range of methodologies – such as network modelling, dynamic evolutionary macroeconomic modelling and financial econometrics – to analyse climate-related financial risks and the implications of financial policies and instruments aiming at the low-carbon transition. The research insights of these contributions can inform the decisions of central banks and financial supervisors about the integration of climate change considerations into their policies and financial risk assessment
Default Ambiguity: Credit Default Swaps Create New Systemic Risks in Financial Networks
Full text linkWe study financial networks and reveal a new kind of systemic risk arising from what we call default ambiguity — that is, a situation where it is impossible to decide which banks are in default. Specifically, we study the clearing problem: given a network of banks interconnected by financial contracts, determine which banks are in default and what percentage of their liabilities they can pay. Prior work has shown that when banks can only enter into debt contracts with each other, this problem always has a unique maximal solution. We first prove that when banks can also enter into credit default swaps (CDSs), the clearing problem may have no solution or multiple conflicting solutions, thus leading to default ambiguity. We then derive sufficient conditions on the network structure to eliminate these issues. Finally, we discuss policy implications for the CDS market
Systemic Risk in Financial Networks
Full text linkFinancial inter-linkages play an important role in the emergence of financial instabilities and the formulation of systemic risk can greatly benefit from a network approach. In this paper, we focus on the role of linkages along the two dimensions of contagion and liquidity, and we discuss some insights that have recently emerged from network models. With respect to the issue of the determination of the optimal architecture of the financial system, models suggest that regulators have to look at the interplay of network topology, capital requirements, and market liquidity. With respect to the issue of the determination of systemically important financial institutions the findings indicate that both from the point of view of contagion and from the point of view of liquidity provision, there is more to systemic importance than just size. In particular for contagion, the position of institutions in the network matters and their impact can be computed through stress tests even when there are no defaults in the system.topology, capital requirements, and market liquidity. With respect to the issue of the determination of systemically important financial institutions the findings indicate that both from the point of view of contagion and from the point of view of liquidity provision, there is more to systemic importance than just size. In particular for contagion, the position of institutions in the network matters and their impact can be computed through stress tests even when there are no defaults in the system
A Financial Macro-Network Approach to Climate Policy Evaluation
Full text linkExisting approaches to assess the economic impact of climate policies tend to overlook the financial sector and to focus only on direct effects of policies on the specific institutional sector they target, neglecting possible feedbacks between sectors, thus, underestimating the overall policy effect. To fill in this gap, we develop a methodology based on financial networks, which allows for analyzing the transmission throughout the economy of positive or negative shocks induced by the introduction of specific climate policies. We apply the methodology to empirical data of the Euro Area to identify the feedback loops between the financial sector and the real economy both through direct and indirect chains of financial exposures across multiple financial instruments. By focusing on climate policy-induced shocks that affect directly either the banking sector or non-financial firms, we analyze the reinforcing feedback loops that could amplify the effects of shocks on the financial sector and then cascade on the real economy. Our analysis helps to understand the conditions for virtuous or vicious cycles to arise in the climate-finance nexus and to provide a comprehensive assessment of the economic impact of climate policies
Interconnectedness as a source of uncertainty in systemic risk
No full textFinancial networks have shown to be important in understanding systemic events in credit markets. In this paper, we investigate how the structure of those networks can affect the capacity of regulators to assess the level of systemic risk. We introduce a model to compute the individual and systemic probability of default in a system of banks connected in a generic network of credit contracts and exposed to external shocks with a generic correlation structure. Even in the presence of complete knowledge, we identify conditions on the network for the emergence of multiple equilibria. Multiple equilibria give rise to uncertainty in the determination of the default probability. We show how this uncertainty can affect the estimation of systemic risk in terms of expected losses. We further quantify the effects of cyclicality, leverage, volatility and correlations. Our results are relevant to the current policy discussions on new regulatory framework to deal with systemic events of distress as well as on the desirable level of regulatory data disclosure
Asset-level assessment of climate physical risk matters for adaptation finance
Full text linkClimate physical risk assessment is crucial to inform adaptation policies and finance. However, science-based and transparent solutions to assess climate physical risks are limited, compounding the adaptation gap. This is a main limitation to fill the adaptation gap. We provide a methodology that quantifies physical risks on geolocalized productive assets, considering their exposure to chronic and acute impacts (hurricanes) across the scenarios of the Intergovernmental Panel on Climate Change. Then, we translate asset-level shocks into economic and financial losses. We apply the methodology to Mexico, a country highly exposed to physical risks, recipient of adaptation finance and foreign investments. We show that investor losses are underestimated up to 70% when neglecting asset-level information, and up to 82% when neglecting tail acute risks. Therefore, neglecting the asset-level and acute dimensions of physical risks leads to large errors in the identification of adaptation policy responses, investments and finance tools aimed to build resilience to climate change.The authors develop a methodology to quantify climate physical risks, both chronic and acute, on productive assets. Investor losses are underestimated up to 70% when neglecting asset level information, and up to 82% when neglecting tail acute risks
Portfolio Diversification and Systemic Risk in Interbank Networks
Full text linkThe recent credit crisis of 2007/08 has raised a debate about the so-called knife-edge properties of financial markets. The paper contributes to the debate shedding light on the controversial relation between risk-diversification and financial stability. We model a financial network where assets held by borrowers to meet their obligations, include claims against other borrowers and securities exogenous to the network. The balance-sheet approach is conjugated with a stochastic setting and by a mean-field approximation the law of motion of the system's fragility is derived. We show that diversification has an ambiguous effect and beyond a certain levels elicits financial instability. Moreover, we find that risk-sharing restrictions create a socially preferable outcome. Our findings have significant implications for future policy recommendation
Pandemics, Climate and Public Finance
Full text linkThe outbreak of COVID-19 and the containment measures are having an un-precedented socio-economic impact in the European Union (EU) and elsewhere. The policies introduced so far in the EU countries promote a ‘business as usual’ economic re-cover y. This short-term strategy may jeopardise the mid-to-long-term sustainability and financial stability objectives. In contrast, strengthening the socio-economic resilience against future pandemics, as well as other shocks, calls for recover y measures that are fully aligned to the objectives of the EU Green Deal and of the EU corporate taxation policy. Tackling these long-term objectives is not more costly than funding the current short-term measures. Remarkably, it may be the only way to build resilience to future crises
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