INSPIRE - Enhanced scenarios for climate stress-tests Summary

• The translation of economic losses, conditioned to the occurrence of a scenario, into adjustments in counterparties’ probability of default and financial performance, and thus into adjustments in the value of the securities and financial contracts through which the investor is exposed to such counterparties. [...] • The estimation of the distribution of losses, conditioned to the occurrence of each scenario, and the calculation of financial risk measures such as the VaR or ES, to capture the tails of the loss distribution. [...] • Reconstruction of the ownership chain of the firm and contribution of the asset to the revenues of the firm, in order to assess the impact of climate physical risks at the asset level on a firm’s performance and default probability. [...] The climate-adjusted cost of capital r calculated by the CFR feeds back into the investment decisions of the sector in the IAM, leading to an adjustment in the trajectory of the sector. [...] In contrast, using the proposed approach the orderly or disorderly character of the transition can be obtained endogenously in the model, “Balance-sheet as a function of investors’ expectations of the credibility of the policy.