Default Risk and Transition Dynamics with Carbon Shocks

Sujan Lamichhane

No 2023/174, IMF Working Papers from International Monetary Fund

Abstract: Climate mitigation policies are being introduced around the world to limit global warming, generating new risks to the economy. This paper develops a continuous time heterogeneous agents model to study the impact of carbon pricing policy shocks on corporate default risk and the consequent transition dynamics. We derive a closed-form solution to corporate default probability based on firms' intertemporal optimization decisions and explicitly characterize the transition speed. This allows for studying policy implications in an analytically tractable way. The model is calibrated to different US corporate sectors to quantify the heterogeneous effects of carbon price shocks. While carbon-intensive sectors face increased default risks, there are notable asymmetric effects within sectors. Higher carbon prices increase default risk but also induce faster transition towards the new post-shock steady state with a highly non-linear impact. Our results suggest that once a range of possible price shocks are accounted for, the increase in the cost of capital/risk premiums might be sharply different across sectors.

Keywords: Default risk; climate risk; carbon price; transition dynamics; cost of capital; risk premium.; climate mitigation policy; carbon price shock; policy shock; price shock; default rate; Debt default; Greenhouse gas emissions; Manufacturing; Global (search for similar items in EconPapers)
Pages: 51
Date: 2023-08-25
New Economics Papers: this item is included in nep-dge, nep-ene, nep-env and nep-rmg
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=537993 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2023/174

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().