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467. Climate transition risk to sovereign debt sustainability
Invited abstract in session MD-63: Optimization Model for Novel Risks in Finance and Climate, stream OR in Banking, Finance and Insurance: New Tools for Risk Management.
Monday, 14:30-16:00Room: S14 (building: 101)
Authors (first author is the speaker)
| 1. | Veronica Mammetti
|
| Department of Economic and Social Sciences, La Sapienza Università di Roma | |
| 2. | Giacomo Morelli
|
| Statistics, Sapienza University | |
| 3. | Stavros A. Zenios
|
| Durham University and University of Cyprus |
Abstract
We incorporate integrated assessment models (IAM) of climate change in stochastic debt sustainability analysis (DSA) and study the effects of transition risk on sovereign debt dynamics. Following recent literature on the effects of climate transition on default probabilities, we introduce a climate risk premium into standard DSA. We calibrate this climate transition-debt channel for several eurozone sovereigns. A calibration spanning the Paris Agreement documents a significant increase in transition risk following this agreement. We then use ensembles of IAMs to obtain forward-looking projections of the climate premium under the orderly and disorderly scenarios from the Network for the Greening of the Financial System. Using the combined IAM-DSA model, we identify adverse debt effects from the increasing transition risk across countries and all IAMs. The adverse effects materialize earlier under the orderly transition, but under disorderly transition, they are significantly more impactful. We find, with high confidence level, that modest extra fiscal effort can maintain debt sustainability under orderly transition, albeit this is not the case for disorderly transition. Our analysis also identifies significant quantitative differences across IAMs, although the general conclusions remain consistent across models. We identify significantly different effects among countries depending on their level of debt and climate exposure.
Keywords
- OR in Environment and Climate change
- Financial Modelling
- Programming, Stochastic
Status: accepted
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