Measuring, managing and hedging indirect climate-transition risk

This project aims at studying transition risk for firms and societies, focusing mainly on the indirect risks coming from the supply chain, i.e. from the interconnections among economic activities. While “direct” transition risks, i.e. related to the firm’s own profitability uncertainty, have been the object of many recent studies, the indirect exposure to risks connected with the transition via the supply chain is a key element, though difficult to account for and, for this reason, still largely unexplored. While the study of climate-transition risk is becoming increasingly popular, our project tackles the issue from a novel perspective. In particular, we plan to pursue two main objectives. First, we aim at improving the measurement of firm-level transition risks by disentangling the direct risks, coming directly from the firm’s business, from the indirect ones, arising from the choices of their suppliers. We measure such risks using a mimicking portfolio approach, thus exploiting the information available on the markets through stock prices. Once we have identified the direct and indirect effects related to transition risks, we plan to build on this distinction to study innovative insurance-based hedging solutions, customized to the needs of a specific firm, and market-based, standardized ones. Second, we plan to apply real option analysis to risk-mitigation problems in supply chain risk management, where the production process can be hit by rare and systemic shocks. Such an approach, though well-suited to the framework, is unexplored and novel and can be applied as a tool to analyze both firm-level and macro-economic problems. The project has the goal to foster the debate on the current recognition of transition risks from both the perspective of the firm and the regulators, and hopefully help improve on current risk management practices. The project involves 4 research units and a research teams with highly complementary competences in statistics, econometrics, network analysis, stochastic optimization, asset pricing and insurance risk management, which will be brought together to tackle the ambitious goals of the project.