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The Transmission of Risk through National Economies

In today’s interconnected business and financial systems, the impact of climate’s physical and transition risks could go well beyond the borders of the sector, region and country hit with potential systemic effects.

Looking at physical risks, more extreme and frequent climate-led events (e.g. floods, hurricanes, droughts) could affect firms and economic sectors’ profitability, cascading on other agents and sectors of the value chain, and eventually affecting countries’ macroeconomic fundamentals and economic competitiveness. On the transition risk side, a sudden change in climate policy and regulation could affect firms whose profits are related (directly or indirectly) to fossil fuels’ extraction and combustion. In both cases, the consequences could spread to the financial sector via revaluation of the financial contracts issued by the firms hit by climate change and become systemic.

The analysis of direct and indirect climate shocks’ transmission to the economy and financial sector is crucial to inform the design of fiscal and monetary policies aimed to increase system’s resilience.

SFI’s research on climate risk transmission through the national economy develops and applies robust quantitative methods rooted in financial risk analysis and financial pricing to analyze the socio-economic and financial implications of a disordered transition to a low-carbon economy, vis-à-vis the cost of inaction, and the role of policies to mitigate such risks.