11 Apr 2024

Climate Stress Testing With Multi-Channel Financial Contagion

Thursday, April 11, 4pm

This paper develops climate stress testing for transition risk, incorporating the amplification of losses among financial institutions. We enhance a climate stress testing framework, modelling direct losses across three layers: scenarios, economy, and financial. Contagion effects within the financial system are then considered using a general network valuation model, where various contagion channels are accounted for. We illustrate this model using an empirical case study of developing nations in southern, eastern, and southeastern Asia. Using NGFS scenarios, our findings indicate that financial firms exhibit resilience to transition shocks. These results are dependent on the network topology and valuation framework assumed. Additionally, we explore the policy implications of a carbon tax, revealing that the network can increase losses for financial firms.

Dr Raymond Pang is an Affiliate Senior Researcher at the CFA Institute, focusing on areas of sustainable finance and market resilience. He has a PhD in Financial Mathematics from The London School of Economics and Political Science, focusing on systemic risk and financial networks, where during this time he was also a PhD intern and academic visitor at the Bank of England. He completed his MASt in Applied Mathematics at the University of Cambridge and his BSc in Mathematics at King’s College London.

SGFC will soon release an upcoming practitioner paper highlighting key results, including interactive tools developed to illustrate contagion in financial networks. This research is a collaboration between Dr Raymond and Dr Gireesh Shrimali, Honorary Research Fellow at the Centre for Climate Finance & Investment.