uncertainty about the nature and timing of the policy, behavioral, and technological changes that will occur during the transition to a sustainable economy. this uncertainty could create significant challenges for financial stability. in addition, climate change might be expected to increase financial system vulnerabilities. 11 financial system vulnerabilities could arise if intermediaries engage in financial contracts or take on leverage to shift climate risk in ways that leave the overall system vulnerable to the amplifying effects of shocks. in addition, even well - informed investors could underestimate the likelihood of large shocks related to climate change, resulting in systematic mispricing of risk. this mispricing could occur if the physical effects of climate change arrive sooner or with greater intensity than expected or investors systematically err in their expectations about the transition. finally, see celso brunetti, benjamin dennis, dylan gates, diana hancock, david ignell, elizabeth k. kiser, gurubala kotta, anna kovner, richard j. rosen, and nicholas k. tabor ( 2021 ), “ climate change and financial stability, ” feds notes ( washington : board of governors of the federal reserve system, march 19 ), https : / / www. federalreserve. gov / econres / notes / feds - notes / climate - change - and - financial - stability20210319. htm. - 6vulnerabilities could result if climate risks in the aggregate are systematically correlated across participants in the economy and financial system. these correlated aggregate exposures could be missed by risk models and difficult or impossible to mitigate fully. it might be useful to consider some examples of climate - related risks that could manifest as shocks or increase financial system vulnerabilities or both. 12 one example is property and casualty insurance, which enables financial firms to engage in financial contracts to hedge climate - related risks. while reinsurance contracts and agreements among investors can shift risks across the global financial system, as i noted earlier, some level of risk is likely to remain. 13 a lack of transparency across participants in the financial sector could cause climate - related risks to build up in hidden pockets, embedding vulnerabilities that could result in cascading losses in the event of large - scale adverse weather outcomes or other shocks to asset valuations. we can already see examples of how such ripple effects might work. as physical risks manifest, insurers update the availability and pricing of coverage to more

##s are ultimately likely to be important. 10 there are situations, however, where microprudential and macroprudential goals do not fully align so that it is important to take into account the implications both for individual firms ’ safety and soundness and also for the broader financial system. for example, the use of climate - related risk mitigants such as insurance or financial derivatives may shift risk away from a particular financial institution but may not reduce or eliminate risk from the system as a whole. in developing a framework to address climate - related financial risks, we need to be mindful of this cascade of effects and the implications across the federal reserve ’ s range of responsibilities. financial system shocks and vulnerabilities arising from climate change our macroprudential work program is focused on assessing not only potential climate shocks, but also whether climate change might make the financial system more vulnerable in ways that could amplify these shocks and cause broader knock - on effects that could harm households, businesses, and communities. in some respects, climate change can be seen as similar to other financial stability shocks emanating from outside the financial system, such as covid - 19, which are difficult to predict with precision and can lead to an abrupt reassessment of a broad array of economic and financial outcomes, prices, and incentives. however, climate change shocks differ in a few important ways. unlike episodic or transitory shocks, climate change is an ongoing, cumulative process, which is expected to produce a series of shocks. over time, these shocks can see allison herren lee ( 2021 ), “ public input welcomed on climate change disclosures, ” public statement by the acting chair of the u. s. securities and exchange commission, march 15, https : / / www. sec. gov / news / public - statement / lee - climate - change - disclosures. - 5change the statistical time - series properties of economic variables, making forecasting based on historical experience more difficult and less reliable. the physical properties of the earth ’ s atmosphere shown by scientific climate records and climatological forecasts include the risk of irreversible climate “ tipping points, ” which can cause as yet unseen disruptions in weather systems, regional water supplies, and the habitability of large land masses — at large magnitudes. quantifying the risks and implications of potentially catastrophic climate - related tipping points for the economy and financial system is extremely difficult. second, there is substantial