Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico

Download or read book Delays in Climate Transition Can Increase Financial Tail Risks: A Global Lesson from a Study in Mexico written by Mr. Dimitrios Laliotis and published by International Monetary Fund. This book was released on 2023-08-25 with total page 36 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper explores a novel forward-looking approach to study the financial stability implications of climate-related transition risks. We develop an integrated micro-macro framework with a new class of scenario called delayed-uncertain pathways. An additional stochastic financial modeling layer via a jump-diffusion process is considered to capture continuously changing risks, as well as the potential of large/sudden shocks in the financial markets. We applied this approach to study transition risks in the Mexican financial sector. But the implications are global in scope, and the framework is easily adaptable to other countries. We quantify the projections of future distributions of various risk metrics and, hence, the evolving tail risks due to compounding effects from delays in transitioning to a low-carbon economy and the consequent uncertainty of the future policy path. We find that the longer the delays in transition, the larger the future tail financial risks, which could be material to the overall system.