Working papers
From Sovereign to Corporate Risk: The Driving Role of Financial Uncertainty - Submitted
Sovereign stress does not always spill over to the corporate sector. This paper uncovers the conditions under which risk contagion arises and identifies the firms most exposed. Using monthly sovereign and corporate credit default swap (CDS) spreads for France, Germany, and Italy from 2005 to 2016, I document that the transmission is both regime-dependent and heterogeneous across firms. First, financial-market uncertainty is the key vector of risk transmission. A panel threshold model shows that sovereign shocks have no effect on corporate credit risk when financial uncertainty is low. Conversely, in high-uncertainty regimes, a 10% increase in sovereign CDS raises corporate CDS by about 2\%. Second, firms are differently exposed to sovereign risk: high idiosyncratic volatility and high leverage amplify the propagation of sovereign stress. By contrast, fiscal fundamentals and firms’ sectoral exposure to government policy do not account for the observed nonlinear pattern. Overall, the results indicate that the spillover operates primarily through financial rather than fiscal mechanisms, highlighting the role of market volatility and firm-level financial constraints in the transmission of sovereign risk.
Fiscal policy and transition risk, with S. Carattini, G. Heutel and G. Melkadze [NBER Working Paper] [CEPR Discussion Paper] - R&R at JEEM
We study how climate policy can interact with distortionary fiscal policy and potentially lead to transition risk. Using an environmental dynamic stochastic general equilibrium model that features financial frictions and preexisting labor and capital taxes, we simulate a carbon tax and an abatement subsidy under different scenarios for returning carbon tax revenue or financing the subsidy. %Our findings highlight novel trade-offs along the transition path between efficiency and political feasibility, which are especially relevant in a world without ex-ante green macroprudential policy. We find novel policy implications and important differences between the carbon tax and the subsidy. Under both policies, transition dynamics can differ sharply from long-run outcomes. For the carbon tax, transition dynamics depend on both financial frictions and the choice of revenue recycling. For the abatement subsidy, distortionary financing can generate contractionary transition dynamics, because of financial frictions. Macroprudential policy can mitigate transition risk under the carbon tax but has little effect under the subsidy.
Macroeconomic and Environmental Effects of Climate Policy Uncertainty: A Sectoral Reallocation Perspective, Job Market Paper [Current Version]
This paper investigates sectoral reallocations in an economy where climate policy is uncertain. To this end, it develops a Dynamic General Equilibrium model with two sectors - a polluting one and a non-polluting one, along with climate externality and endogenous firm entry. Climate policy uncertainty stems from the possibility that the government may introduce a carbon tax in the next period. I show that, compared to a scenario without climate policy uncertainty, the probability of implementing carbon taxation prompts entrepreneurs to curtail investment in polluting firms' entry while promoting entry into the non-polluting sector. Through general equilibrium effects, these sectoral reallocations deteriorate welfare, generate a drop in economic activity, and increase CO2 emissions. I provide additional empirical evidence through a VAR model that supports these results. Overall, this paper points out the economic and environmental costs of climate policy uncertainty.
Preference Shocks and Policy Responses to Transition Risk, with S. Carattini and G. Melkadze [CESifo Workking Paper] [CEPR Discussion Paper]
Central banks and financial surveillance authorities need to cope with the potential realization of financial stability risks, adopting preventive measures or using liquidity once crises materialize. Transition risk --- the stability risk associated with decarbonization --- is a case in point. Such risk not only comes from policy changes, but also from preference shocks. Hence, this paper develops an environmental DSGE model with financial frictions and examines responses to shocks, including a novel angle on preference shocks. We show that these market-driven transition shocks generate larger macro-financial instability than carbon pricing for a given change in emissions, while delaying environmental gains. We then compare policy responses according to their timing. Ex-ante macroprudential policies that reduce banks’ exposure to transition risk dampen financial amplification, whereas ex-post interventions, such as quantitative easing, provide only partial stabilization once losses have materialized. Overall, our results indicate that market-led adjustments to transition risk are more destabilizing than carbon pricing, whereas preventive financial measures limit macro-financial instability more effectively than ex-post interventions under the policy comparisons considered, supporting the case for early action.
Time Inconsistency and Reputation in Climate Policy, with A. Titton [Current Version]
We study how climate policy can interact with distortionary fiscal policy and potentially lead to transition risk. Using an environmental dynamic stochastic general equilibrium model that features financial frictions and preexisting labor and capital taxes, we simulate a carbon tax and an abatement subsidy under different scenarios for returning carbon tax revenue or financing the subsidy. %Our findings highlight novel trade-offs along the transition path between efficiency and political feasibility, which are especially relevant in a world without ex-ante green macroprudential policy. We find novel policy implications and important differences between the carbon tax and the subsidy. Under both policies, transition dynamics can differ sharply from long-run outcomes. For the carbon tax, transition dynamics depend on both financial frictions and the choice of revenue recycling. For the abatement subsidy, distortionary financing can generate contractionary transition dynamics, because of financial frictions. Macroprudential policy can mitigate transition risk under the carbon tax but has little effect under the subsidy.
Work in progress
Environmental Dynamic Stochastic General Equilibrium Models, with B. Annicchiarico, S. Carattini, C. Fischer, G. Heutel and A. Sardone
Higher-Order Beliefs and Green Investment: A Coordination Game under Dispersed Information, with E. Campiglio and N. Ziklova