Climate Risk CMES Analysis Page
Options
Users may select values for the following options and see the effect on CRISK:
- Crisis Threshold: We define a climate crisis as occurring when the stranded assets portfolio falls by more than the crisis threshold in a six-month period. The default crisis threshold is 50%. Users may change the crisis threshold by entering a value into the spinner above the CRISK Graph.
- Prudential Capital Requirement (k): The prudential capital requirement is the amount of capital, expressed as a share of assets, that a firm would need to weather a financial crisis. Typically, well managed large financial institutions in normal times maintain a capital ratio of 8% for firms in Africa, Asia and Americas and 5.5% for firms in Europe. Users may change the prudential capital requirements by entering values in the spinners in the Capital Req section of the options side bar.
- Percentage of Separate Accounts to Include: Insurance companies, especially life insurance companies, have important accounting characteristics that require CRISK adjustments. In these companies, premiums are accumulated in investment funds such as variable annuities. These can be withdrawn often with penalties, and have payouts often at guaranteed levels. These are reported in separate accounts, which appear as both assets and liabilities on the balance sheet. For insurance companies in calm times, typical capital ratios come to about 8% when 40% of separate accounts are included. This matches the default prudential capital requirement for other financial firms. Hence, the default percentage of separate accounts that is included in total liabilities is 40%. Users may change the percentage of Separate Accounts that is included by entering a value in the spinner in the separate accounts section of the options side bar.
CRISK Graph
The CRISK Graph displays a plot of the CRISK series for a given firm. Users may select a firm from the Climate Risk Rankings Table below the CRISK Graph. Users may also select a different series type to display from the Series drop down menu.
Climate Risk Rankings Table
The Climate Risk Rankings Table displays:
- CRISK is the expected capital shortfall of a financial firm in a climate crisis where the stranded assets portfolio falls by more than 50% in a six-month period. A financial firm will be unable to function when the value of its equity falls to a sufficiently small fraction of its outstanding liabilities. In good times, such a firm will likely be acquired, may be able to raise new capital or may face an orderly bankruptcy. If this capital shortage occurs at a time when the financial sector is already financially constrained, then the government faces the question of whether to rescue the firm with taxpayer money as other avenues are no longer available. In the theoretical analysis of Acharya, Pederson, Phillipon and Richardson (2010), such a capital shortage is damaging to the real economy as the failure of this firm will have repercussions throughout the financial and real sectors. Consequently a firm is systemically risky if it is likely to face a capital shortage just when the financial sector itself is weak. This climate risk measure,CRISK, is calculated as k*Debt-(1-k)*(1-LRMES)*MV, where LRMES, the expected fractional loss of the equity when the Stranded Assets Portfolio falls by the crisis threshold (default is 50%) in a six-month period. The prudential capital requirement k is set to be 8% for firms in Africa, Asia and Americas and 5.5% for firms in Europe. The user can adjust the crisis threshold and/or the prudential capital requirement in the side bar to see the effect on CRISK.
- CRISK% is the proportional contribution of each firm'sCRISK to the total positive CRISK of the financial system.
- Marginal CRISK is the difference in CRISK with the currently-selected market decline and CRISK with a 0% market decline.
- LRMES, or Long-Run Marginal Expected Shortfall, is the expected fractional loss of the firm equity when the stranded assets portfolio declines significantly in a six-month period. It is calculated as 1-exp(log(1-d)*beta), where d is the six-month crisis threshold for the stranded assets decline and its default value is 50%; and beta is the firm's Dynamic Conditional Beta. The user can adjust the crisis threshold by a 5% increment in the side bar to see the effect on LRMES.
- Climate Beta is the Beta of the firm with respect to the stranded assets portfolio, using Rob Engle's Dynamic Conditional Beta model. In the calculation, asynchronous prices are taken into account. For more details, also consult the documentation on Dynamic Conditional Beta (DCB).
- Cor is the dynamic conditional correlation between the equity return on a stock and the return on the Stranded Assets Portfolio. It is estimated with a DCC model that is updated daily.
- Vol is the annualized volatility of the equity of the company. It is estimated with a GJR-GARCH model that is updated daily.
- Lvg is the Quasi Leverage of a company which is 1 plus its book value of liabilities divided by its market value of equity. For those firms with separate accounts, liabilities are reduced by the proportion of separate accounts to include in theCRISK calculation. See the Options section for more details on how separate accounts are used in the calculation of CRISK and how to change the amount included in the calculation.
- Stressed Lvg is the forecasted Quasi Leverage of a company during a crisis. It is defined as:For those firms with separate accounts, liabilities are reduced by the proportion of separate accounts to include in theCRISK calculation. See the Options section for more details on how crisis thresholds and separate accounts are used in the calculation of CRISK and how to change the amount included in the calculation.