Climate Risk Stress Testing: A Conceptual Review

Henk Jan Reinders, Dirk Schoenmaker and Mathijs Van Dijk

No 17921, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We conceptually review Climate Risk Stress Testing (CRST) approaches to assess the impact of climate-related shocks on financial system stability. We distinguish between climate, economic, and financial modeling steps, and identify six types of climate shocks and four different approaches (macro-financial, micro-financial, non-structural, and disaster risk). Our review identifies several key limitations in current CRST approaches: (i) neglect of certain climate shock types (Green Swan and Minsky-type events); (ii) overreliance on macro models (with low sectoral and spatial granularity); (iii) incomplete modeling (lack of feedback effects); and (iv) limited scope (subset of causal channels and asset classes). We argue that these limitations may lead to significant underestimation of potential system-wide financial losses and offer suggestions for improving CRST approaches.

Keywords: Climate stress test; Merton model; Integrated assessment model (search for similar items in EconPapers)
JEL-codes: E10 G13 G17 H23 Q54 (search for similar items in EconPapers)
Date: 2023-02
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