Climate stress testing has become a key tool to assess firm-level transition risks and how these propagate to financial institutions and the financial system. Yet, current practices often rely on historical and sector-averaged data that obscure firm-level ambition and within sector heterogeneity. We develop a stylized model of irreversible firm-level investment to simulate belief-driven early and late-mover behavior in low-carbon production investment and apply it to the European steel sector. We show stress-testing scenarios based primarily on carbon pricing generate broad and overlapping valuation outcomes for the early and late mover firm, even when forward-looking firm strategies are taken into account, reflecting uncertainty in cost pass-through and carbon leakage protection. By contrast, an accelerated policy-mix scenario combining price and policy incentives with primary demand reductions produces a sharper transition shock, leading to a clear differentiation between aligned and non-aligned firms with the transition. Overall, the results show that the use of forward-looking firm data is as critical as the choice of a sufficiently stringent transition scenario. The latter ensures that climate stress test results are informative for financial risk management or capital allocation and pricing.
