Lending and Climate Change: Challenges and Solutions
Paper Session
Saturday, Jan. 7, 2023 10:15 AM - 12:15 PM (CST)
- Chair: Galina Hale, University of California-Santa Cruz
Asset Overhang and Technological Change
Abstract
Investors face reduced incentives to finance projects that devalue their legacy investments. We formalize this "asset overhang" and study its drivers. We apply our framework to the climate-banking nexus, where the net-zero transition effectively poses a dilemma for banks: while environmental innovation can be profitable, its widespread dissemination risks disrupting the value of legacy positions. Using granular firm-level data on innovation and diffusion of environmental goods & services, we document the presence of asset overhang as innovators (diffusors) of disruptive environmental technologies are approximately 4.4 p.p. (1.0 p.p) less likely to receive bank credit compared to non-disruptive counterparts. Individual investors with less legacy positions at risk mitigate the economywide asset overhang problem, thereby facilitating technological transition.ESG Commitment and the Value of `Walking the Talk’: Evidence from Closed-End Funds
Abstract
We investigate whether and how corporate ESG commitment can increase shareholder value. Using closed-end funds as an empirical laboratory, we find that funds committing to the U.N. Principles for Responsible Investment (PRI) are traded at a higher premium only when they "walk their talk" by increasing the ESG scores of their portfolios. The individual effect of the commitment itself is not significant. The positive impact of "walking the talk" is stronger when ESG-related regulations become more stringent. Overall, our analysis suggests that firms' ESG commitment can lead to higher firm value when they can credibly "walk their talk" and this benefit is related to the direction of ESG regulations.Climate Linkers: Rationale and Pricing
Abstract
This paper envisions climate linkers. We define climate linkers as long-dated financial instruments (bonds, swaps, and options) with payoffs indexed to climate-related variables, e.g., temperatures, sea levels, or carbon concentrations. On top of facilitating the sharing of long-term climate risks, another key benefit of these instruments would be informational, as their prices would reveal real-time market expectations regarding future climate. We develop and calibrate a sea-level-augmented integrated assessment model (IAM), and we exploit it to study climate-linked instruments’ cost and risk characteristics. We examine, in particular, climate risk premiums: because of the insurance provided by a bond indexed on sea levels (say), investors would demand a lower average return on such a bond than on conventional bonds. Our findings highlight the sensitivity of climate premiums to the assumptions regarding (i) the damages associated with temperature increases and (ii) feedback effects between temperatures and carbon emissions.Discussant(s)
Toan Phan
,
Federal Reserve Bank of Richmond
Francis X. Diebold
,
University of Pennsylvania
Sarah Mouabbi
,
Bank of France
Christian Heyerdahl-Larsen
,
Indiana University
JEL Classifications
- G1 - Asset Markets and Pricing
- G2 - Financial Institutions and Services