Job Market Paper

Real Consequences of Shocks to Intermediaries Supplying Corporate Hedging Instruments
Accepted at Review of Financial Studies
Dissertation Committee: Robert Engle (Co-chair), Philipp Schnabl (Co-chair), Ralph Koijen, Alexi Savov, and Joel Hasbrouck

AEA, NBER IFM Meeting, IMF Macro-Financial Research Conference, WEAI-IBEFA Conference, HEC Paris-CEPR Conference, EFA, Bank of Korea, Australasian Finance and Banking Conference, International Risk Management Conference, Korea University, HKUST, Vanderbilt Owen, Yale SOM, Federal Reserve Bank of New York, Federal Reserve Board, Stockholm School of Economics, Federal Reserve Bank of Chicago, Warwick Business School, U of SC Darla Moore, Oxford Said, Imperial College London, HKU, Federal Reserve Board (Pre-Job Market Conference), SoFiE Seminar ( Video), NYU Stern

View Abstract      Blog I show that shocks to financial intermediaries that supply hedging instruments to corporations have real effects. I exploit a quasi-natural experiment in South Korea in 2010, where regulations required banks to hold enough capital for taking positions in foreign exchange derivatives (FXD). Using the variation in exposure to this regulation across banks, I find that the regulation caused a reduction in the supply of FXD, leading to a significant decline in exports for firms that held derivatives contracts with more exposed banks. These results indicate the crucial role of intermediaries in allocating risks through the provision of derivatives and establish a causal relationship between financial hedging and real economic outcomes.

Working Papers

CRISK: Measuring the Climate Risk Exposure of the Financial System
Co-authors: Robert Engle and Richard Berner
R&R at Journal of Financial Economics
Berkeley Haas Sustainability Research Prize Finalist

AEA, Paris December Finance Meeting, UN PRI Academic Network Week, OFR Climate Implications for Financial Stability Conference, CEBRA, EFA, International Journal of Central Banking Conference, Cornell University ESG Investing Research Conference, Banco de Portugal Conference on Financial Intermediation, OCC Symposium, ESRB Workshop, NY Fed-Columbia University Conference, System Climate Meeting by the Federal Reserve Bank of San Francisco, University of Oklahoma Energy and Climate Finance Research Conference, Federal Reserve Board, Banque de France Workshop, ESSEC-Amundi Chair Webinar, Federal Reserve Bank of Richmond, Australasian Finance and Banking Conference*, (EC)^2 Conference, European Central Bank, MIT GCFP Conference, Central Bank of Chile Workshop, Federal Reserve Stress Testing Research Conference, Federal Reserve Bank of New York, IFABS Oxford Conference, Green Swan Conference*, EBA EAIA Seminar*, Volatility and Risk Institute Conference ( Video)

View Abstract      Blog       Berkeley Haas Sustainability Research Brief We develop a market-based methodology to assess banks’ resilience to climate-related risks and study the climate-related risk exposure of large global banks. We introduce a new measure, CRISK, which is the expected capital shortfall of a bank in a climate stress scenario. To estimate CRISK, we construct climate risk factors and dynamically measure banks’ stock return sensitivity (that is, climate beta) to the climate risk factor. We validate the climate risk factor empirically and the climate beta estimates by using granular data on large U.S. banks’ loan portfolios. The measure is useful in quantifying banks’ climate-related risk exposure through the market risk and the credit risk channels.

U.S. Banks’ Exposures to Climate Transition Risks
Co-authors: Joao Santos and Lee Seltzer

Federal Reserve Bank of Cleveland*, System Climate Meeting by the Federal Reserve Bank of San Francisco, OCC Symposium*, IFABS Oxford Conference*, ASSA IBEFA, Stanford Institute for Theoretical Economics Conference, NY Fed-Columbia University Conference*, American Bankers Association, Federal Reserve Board, E-axes Young Scholar’s Webinar, CBRT-IFC Workshop*, the Climate and Biodiversity Conference by Banque de France*, Banca d’Italia and the IMF Conference, EFA*

View Abstract      Blog We find that banks' credit exposures to transition risks are modest. We build on the estimated sectoral effects of climate transition policies from general equilibrium models. Even when we consider the strictest policies or the most adverse scenarios, exposures do not exceed 14% of banks' loan portfolios. We also find that commonly used carbon emissions can explain at most 60% of bank exposures estimated off general equilibrium models. Moreover, we find evidence of bank management of transition risk exposures. Banks that signed the Net-Zero Alliance have reduced their exposures compared to non-signatories, mainly by cutting lending to the riskiest industries.

Measuring the Climate Risk Exposure of Insurers
Co-authors: Robert Engle, Shan Ge, and Xuran Zeng

FHFA Econ Summit, System Banking Conference by the Federal Reserve Board, Financial Stability Conference by the Cleveland Fed and the OFR, NY Fed, Central Bank of Chile Annual Conference ( Video), Greater New York Finance Women Symposium*, Midwest Finance Association Meeting, Federal Reserve Board*, Baruch Conference* (Poster), CESifo Conference on Energy and Climate Economics, Columbia, ZEW Conference, WEAI-IBEFA Conference, Banca d’Italia and the IMF Conference, Volatility and Risk Institute Conference*, Global Research Alliance for Sustainable Finance and Investment (GRASFI) Conference, Yale Initiative on Sustainable Finance Symposium, Stanford Institute for Theoretical Economics Conference

View Abstract      Blog Insurance companies can be exposed to climate-related physical risk through their operations and to transition risk through their $12 trillion of financial asset holdings. We assess the climate risk exposure of property and casualty (P&C) and life insurance companies in the U.S. We construct a novel physical risk factor by forming a portfolio of P&C insurers’ stocks, with each insurer’s weight reflecting their operational exposure to states associated with high physical climate risk. We then estimate the dynamic physical climate beta, representing the stock return sensitivity of each insurer to the physical risk factor. In addition, using the climate beta estimates introduced by Jung et al. (2021), we calculate the expected capital shortfall of insurers under various climate stress scenarios. We validate our approach by utilizing granular data on insurers’ asset holdings and state-level operational exposure. Our findings indicate a positive association between larger exposures to risky states and higher holdings of brown assets with higher sensitivity to physical and transition risk, respectively.

Climate Stress Testing
Co-authors: Viral Acharya, Robert Engle, Richard Berner, Johannes Stroebel, Xuran Zeng, and Yihao Zhao

Indian Institute of Management Ahmedabad, Central Bank of Brazil, European Central Bank, IMF

Prepared for the Annual Review of Financial Economics

View Abstract We explore the design of climate stress tests to assess and manage macro-prudential risks from climate change in the financial sector. We review the climate stress scenarios currently employed by regulators, highlighting the need to (i) consider many transition risks as dynamic policy choices; (ii) better understand and incorporate feedback loops between climate change and the economy; and (iii) further explore "compound risk" scenarios in which climate risks co-occur with other risks. We discuss how the process of mapping climate stress scenarios into financial firm outcomes can incorporate existing evidence on the effects of various climate-related risks on credit and market outcomes. We argue that more research is required to (i) identify channels through which plausible scenarios can lead to meaningful short-run impact on credit risks given typical bank loan maturities; (ii) incorporate bank-lending responses to climate risks; (iii) assess the adequacy of climate risk pricing in financial markets; and (iv) better understand and incorporate the process of expectations formation around the realizations of climate risks. Finally, we discuss the relative advantages and disadvantages of using market-based climate stress tests that can be conducted using publicly available data to complement existing stress testing frameworks.

Deviations from the Law of One Price across Economies
Co-author: Jaehoon (Kyle) Jung

WAPFIN @ Stern Conference, Australasian Finance and Banking Conference*, Columbia GSB Finance Ph.D. Seminar, NYU Stern

View Abstract       

AFA Poster

In a model with agents facing constraints heterogeneous across economies, we provide a novel explanation for an understudied yet economically significant deviation from the Law of One Price across FX forward markets. Specifically, we document a substantial divergence between the exchange rate for locally traded forward contracts and contracts with the same maturity traded outside the jurisdiction of countries during the global financial crisis, and that the magnitudes varied across currencies. The model predicts that (1) the basis increases with the shadow costs of constraints across time and increases with the country-specific FX position limits across countries; (2) the shadow cost of each constraint non-linearly increases as the intermediary sector’s relative performance declines below a threshold; and (3) higher shadow cost of the position limit predicts lower future excess return on local-currency denominated assets, as buying local assets relaxes the FX position limit constraint imposed on the intermediaries. We test the model predictions and find consistent evidence in countries with tight position limits.

(Presentations including scheduled; * presented by co-author)