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Climate Risk Stress Testing: A Conceptual Review

Author

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  • Schoenmaker, Dirk
  • Reinders, Henk Jan
  • Van Dijk, Mathijs

Abstract

We conceptually review Climate Risk Stress Testing (CRST) approaches to assess the impact of climate-related shocks on financial system stability. We distinguish between climate, economic, and financial modeling steps, and identify six types of climate shocks and four different approaches (macro-financial, micro-financial, non-structural, and disaster risk). Our review identifies several key limitations in current CRST approaches: (i) neglect of certain climate shock types (Green Swan and Minsky-type events); (ii) overreliance on macro models (with low sectoral and spatial granularity); (iii) incomplete modeling (lack of feedback effects); and (iv) limited scope (subset of causal channels and asset classes). We argue that these limitations may lead to significant underestimation of potential system-wide financial losses and offer suggestions for improving CRST approaches.

Suggested Citation

  • Schoenmaker, Dirk & Reinders, Henk Jan & Van Dijk, Mathijs, 2023. "Climate Risk Stress Testing: A Conceptual Review," CEPR Discussion Papers 17921, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:17921
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    More about this item

    Keywords

    Climate stress test; Merton model; Integrated assessment model;
    All these keywords.

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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