Low‐carbon transition risks for finance

The transition to a low‐carbon economy will entail a large‐scale structural change. Some industries will have to expand their relative economic weight, while other industries, especially those directly linked to fossil fuel production and consumption, will have to decline. Such a systemic shift may have major repercussions on the stability of financial systems, via abrupt asset revaluations, defaults on debt, and the creation of bubbles in rising industries. Studies on previous industrial transitions have shed light on the financial transition risks originating from rapidly rising “sunrise” industries. In contrast, a similar conceptual understanding of risks from declining “sunset” industries is currently lacking. We substantiate this claim with a critical review of the conceptual and historical literature, which also shows that most literature either examines structural change in the real economy, or risks to financial stability, but rarely both together. We contribute to filling this research gap by developing a consistent theoretical framework of the drivers, transmission channels, and impacts of the phase‐out of carbon‐intensive industries on the financial system and on the feedback from the financial system into the rest of the economy. We also review the state of play of policy aiming to protect the financial system from transition risks and spell out research implications

PRUDENT DISCOUNTING: EXPERIMENTAL EVIDENCE ON HIGHER ORDER TIME RISK PREFERENCES

We report results from an experiment that contrasts preferences toward the risk of what may happen (outcome risk preferences) with preferences toward the risk of when something may happen (time or delay risk preferences). Just as choices over monetary risks identify utility independently from discounting, choices over uncertain delays of a fixed reward identify discounting independently from utility. We replicate the widespread finding of outcome risk aversion, but—in a perfectly symmetric design—find substantial heterogeneity in delay risk aversion. Going beyond the second order of risk aversion, on the other hand, yields pervasive evidence for delay prudence and outcome prudence alike. This first empirical support for prudent discounting speaks to recent theoretical arguments that prudence may be a more important trait than previously realized