Conference Agenda

Climate stress testing aims to assess firm-level transition risks and how these propagate to financial institutions and the financial system. We examine how climate stress-testing scenario design affects the quantification and comparability of firm-level transition risks under a common transition shock. We develop a stylized model of firm-level investment in low-carbon production capacity under climate policy uncertainty, applied to the European steel sector. Two identical firms differ only in their expectations about future climate policy scenarios, capturing belief-driven early- and late-mover behavior in low-carbon production investment. Firm cash flows depend on investment timing, capital and operating costs, policy support, carbon pricing and demand for primary steel. We show that stress-testing scenarios based primarily on carbon pricing generate broad and overlapping valuation outcomes for the early and late mover firm, reflecting uncertainty in cost pass-through and carbon leakage protection. By contrast, an accelerated policy-mix scenario combining price incentives with binding product bans and demand reductions produces a sharper transition shock, leading to a clear differentiation between early and late movers. Overall, the results show that the use of a sufficiently stringent transition scenario is critical for ensuring the comparability and informativeness of firm-level climate stress tests for financial risk management.