Working Paper

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 competitive-equilibrium 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.

Keywords: climate finance; sea-level rise; heterogeneous beliefs; real estate; mortgage; search and matching; monetary policy;

https://doi.org/10.21144/wp23-01

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2023-01

Number: 23-01