The impact of climate change on systemic risk

: a top-down assessment of transition risk in the Eurozone

Abstract

This thesis analyzes the effect of transition risk from climate change on systemic risk in the financial sector in the Eurozone by estimating the expected capital shortfall of 237 publicly listed financial institutions in the Eurozone, conditional on a climate stress scenario, focusing on trends and concentration patterns. The capital shortfall is estimated utilizing a market-based top-down climate stress test methodology introduced by Jung et al. (2023), by first estimating time-varying Climate Betas for each financial institution through a rolling regression of the company stock returns on the returns of a Stranded Asset Portfolio, which is constructed to serve as a proxy for transition risk. Next, the variable CRISK is estimated, representing the expected capital shortfall of each financial institution under a stress scenario, represented by 50% decline in the return of the Stranded Asset Portfolio over a six-month period. The advantage of this methodology is that it estimates climate risk dynamically, and thus addresses its time-varying nature. Furthermore, it requires only publicly available data and relies on minimal assumptions (Jung et al., 2023). The findings of the analysis in this research thesis reveal a positive aggregate average CRISK of EUR 594,39 billion for the data sample, with differences in the distribution of CRISK among countries, sub-industries and individual financial institutions, and a significant upward trend in aggregate CRISK values throughout the observation period. In addition, the mean aggregate marginal CRISK, representing the difference in CRISK compared with a non-stressed scenario, is EUR 40,42 billion.

Date of Award	17 Oct 2023
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Filippo De Marco (Supervisor)