Climate Stress Testing

Viral V. Acharya, Richard Berner, Robert Engle, Hyeyoon Jung, Johannes Stroebel, Xuran Zeng and Yihao Zhao
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Viral V. Acharya: Stern School of Business, New York University, New York, NY, USA
Richard Berner: Stern School of Business, New York University, New York, NY, USA
Hyeyoon Jung: Federal Reserve Bank of New York, New York, NY, USA
Xuran Zeng: Stern School of Business, New York University, New York, NY, USA
Yihao Zhao: Stern School of Business, New York University, New York, NY, USA

Annual Review of Financial Economics, 2023, vol. 15, issue 1, 291-326

Abstract: We explore the design of climate stress tests to assess and manage macroprudential risks from climate change in the financial sector. We review the climate stress scenarios currently employed by regulators, highlighting the need to (a) consider many transition risks as dynamic policy choices, (b) better understand and incorporate feedback loops between climate change and the economy, and (c) further explore compound risk scenarios in which climate risks co-occur with other risks. We discuss how the process of mapping climate stress scenarios into financial firm outcomes can incorporate existing evidence on the effects of various climate-related risks on credit and market outcomes. We argue that more research is required to (a) identify channels through which plausible scenarios can lead to meaningful short-run impact on credit risks given typical bank loan maturities, (b) incorporate bank-lending responses to climate risks, (c) assess the adequacy of climate risk pricing in financial markets, and (d) better understand how market participants form climate risk expectations and how that affects financial stability. Finally, we discuss the advantages and disadvantages of using market-based climate stress tests that can be conducted with publicly available data to complement existing stress-testing frameworks.

Keywords: climate risk; financial stability; systemic risk (search for similar items in EconPapers)
JEL-codes: G1 G2 Q54 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (8)

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Related works:
Working Paper: Climate Stress Testing (2023)
Working Paper: Climate Stress Testing (2023)
Working Paper: Climate Stress Testing (2023)
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DOI: 10.1146/annurev-financial-110921-101555

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