Staff Reports
Climate Stress Testing
Number 1059
April 2023

JEL classification: Q54, G1, G2

Authors: Viral V. Acharya, Richard Berner, Robert Engle, Hyeyoon Jung, Johannes Stroebel, Xuran Zeng, and Yihao Zhao

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 (i) consider many transition risks as dynamic policy choices; (ii) better understand and incorporate feedback loops between climate change and the economy; and (iii) 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 (i) identify channels through which plausible scenarios can lead to meaningful short-run impact on credit risks, given typical bank loan maturities; (ii) incorporate bank-lending responses to climate risks; (iii) assess the adequacy of climate risk pricing in financial markets; and (iv) better understand and incorporate the process of expectations formation around the realizations of climate risks. Finally, we discuss the relative advantages and disadvantages of using market-based climate stress tests that can be conducted using publicly available data to complement existing stress testing frameworks.

Available only in PDF pdf
AUTHOR DISCLOSURE STATEMENT(S)

Viral V Acharya declares that he has no relevant or material financial interests that relate to the research described in this paper.

Richard Berner declares that he has no relevant or material financial interests that relate to the research described in this paper.

Robert Engle declares that he has no relevant or material financial interests that relate to the research described in this paper.

Hyeyoon Jung declares that she has no relevant or material financial interests that relate to the research described in this paper. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html

Johannes Stroebel declares that he has no relevant or material financial interests that relate to the research described in this paper.

Xuran Zeng declares that she has no relevant or material financial interests that relate to the research described in this paper.

Yihao Zhao declares that she has no relevant or material financial interests that relate to the research described in this paper.

By continuing to use our site, you agree to our Terms of Use and Privacy Statement. You can learn more about how we use cookies by reviewing our Privacy Statement.   Close