Estimating the Impact of Physical Climate Risks on Firm Defaults: A Supply-Chain Perspective

Abstract: In this research, an agent-based model was developed to study the propagation of climate shocks through supply chain networks and their implications on firm defaults. The model is based on stateof-the-art research on the ripple effect in supply chain networks and extended with the Merton Model to enable the modelling of firm defaults. Physical climate risks are modelled stochastically based on historic climate events. Various scenarios, that represent the uncertainty in climate projections and their economic impact, have been investigated. The results indicate that supply chains are an important transmission channel of physical climate risk. Indeed, the scenario representing a modest increase in the frequency and economic impact of climate events estimates an increase between 12.08% and 15.93% in the average default probability of firms. Furthermore, sensitivity analysis was used to provide guidance for policymakers on which adaptation measures should be prioritized.