Leveraging the Disagreement on Climate Change: Theory and Evidence

Abstract

We theoretically and empirically investigate how climate risks affect collateralized debt markets. First, we develop a debt model where agents have different beliefs over a long-run risk. In contrast with existing two-period competitiveequilibrium models, our infinite-horizon competitive-search model predicts more pessimistic agents are more likely to make leveraged investments on risky collateral assets. They also tend to use longer maturity debt contracts, which are more exposed to the long-run risk. Second, employing large data on real estate and mortgage transactions, combined with high resolution sea-level-rise maps, we find robust evidence for these findings. We also show how monetary and securitization policies affect mortgage climate risk exposure. Our results highlight the importance of heterogeneous beliefs in understanding the effects of climate change on the financial system.

Mortgage Securitization Dynamics in the Aftermath of Natural Disasters: A Reply

“…The paper finds evidence consistent with the Climate Securitization Hypothesis as the SLR premium is significantly (economically and statistically) higher for jumbo mortgages that are not eligible for securitization by the agencies (Table VIII, page 1538). Bakkensen, Phan & Wong (2023) presents both a theoretical model and an empirical analysis of the choice of debt when agents have beliefs over the future evolution of risk in a specific area.…”

“…This is consistent with the evidence in Hertzberg, Liberman & Paravisini (2016) suggesting a positive correlation between the leverage and the pessimistic beliefs of the agents. In Bakkensen et al (2023), this leverage also manifests in longer maturity loans. The paper provides empirical evidence for the climate securitization hypothesis.…”

“…In the real economy, margins of adjustment include migration (Deryugina, Kawano & Levitt 2018, Smith, Carbone, Pope, Hallstrom & Darden 2022, home price declines (Ortega & Taspinar 2018, Cohen et al 2021, and public finance dynamics (Healy & Malhotra 2009, Jerch, Kahn & Lin 2023. In the financial sector, as investment and consumption are typically leveraged (Geanakoplos 2010) , margins of adjustment in response to climate risk exposure include the LTV ratios (Sastry 2021, Bakkensen et al 2023, interest rates and yields (Goldsmith-Pinkham, Gustafson, Lewis & Schwert 2022, Nguyen et al 2022), approval rates, amortization structures of loans. In the financial sector, risk is hedged using risk transfers (Gete & Tsouderou 2022) and derivative products (Ouazad 2022b).…”

Cap. 19. La economía. En: La Quinta Evaluación Nacional del Clima

“…Por ejemplo, el descenso del valor de las propiedades debido al cambio climático podría afectar negativamente los mercados hipotecarios y los balances de las instituciones financieras, lo que podría provocar angustias financieras, especialmente si los riesgos climáticos no se valoran de manera adecuada o si se concentran en empresas patrocinadas por el gobierno 202,206,207,208,209,210 . Aunque se necesita más investigación para comprender estos efectos sistémicos, algunos riesgos subyacentes pueden gestionarse.…”

Chapter 19 : Economics. Fifth National Climate Assessment

“…For example, declines in property values due to climate change could adversely affect mortgage markets and financial institutions' balance sheets, potentially leading to financial distress, especially if climate risks are imperfectly priced or if they are concentrated in government-sponsored enterprises. 202,206,207,208,209,210 While more research is needed to understand these systemic effects, some underlying risks can be managed. For example, the risk of future asset price corrections, driven by misalignment between current prices and the expected effects of climate change, 57,101,102,103,109,211 can be reduced through communication and disclosure of climate risks to market actors.…”