Heterogeneous climate tail risks, carbon capture and storage, and cap-and-trade in a supply chain through sustainable insurance

Abstract This paper introduces a capped call option framework to analyze the impact of climate tail risks (CTRs), cap-and-trade, and carbon capture and storage (CCS) on equity and risk in a supply chain, offering new insights into their effects on financial stability with sustainable insurance. The results of this study indicate that heightened CTRs exposure for insurers reduces equity across all supply chain entities. When CTRs arise from upstream sources, they significantly diminish upstream manufacturers’ equity; conversely, downstream CTRs appear to increase the equity of downstream manufacturers, reflecting an asymmetric valuation effect. Stricter emissions caps reduce equity for both insurers and manufacturers while amplifying default risk for insurers and downstream firms, yet mitigating default risk for upstream manufacturers. Additionally, increased utilization of CCS leads to equity declines across all entities. It also elevates default risk for insurers and downstream manufacturers, while simultaneously reducing it for upstream manufacturers and the supply chain. These findings underscore the heterogeneous impacts of CTRs, cap-and-trade regulations, and CCS adoption, emphasizing the need for regulators to tailor climate policy frameworks to sector-specific risk dynamics within supply chains.