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I am looking for resources on applicable and practical solutions for estimation and quantifying climate change risk from asset owners perspective (for example, a portfolio of equity, fixed income, and their derivatives). BIS published several papers/reports on this but they are largely related to banking sector.

In particular, I am interested in stress testing, scenario analysis, VaR, and other metrics that could be useful in estimating climate change risk.

As I was not able to find anything practical, I am willing to look at both asset class specific approaches as well as integrated cross asset methodologies. For example, pertinent to equities, we could potentially create a benchmark index that represents the "climate change" factor and look at the relationship between this factor and equity holdings in the portfolio.

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    $\begingroup$ @nick012000 - Only if you assume that they're going to get swamped. Most sea level rise models show that coastal assets will be subject to a rise of only a few tens of millimetres in our lifetimes whereas to read the popular press, you'd think that they were already half-submerged. Perhaps you can buy from panicky idiots who read the headlines and not the actual studies. $\endgroup$
    – Valorum
    Commented Jul 17, 2021 at 16:29
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    $\begingroup$ @nick012000 People usually try to quantify 3 kinds of ESG-related risks. Physical Risk - how will the company be affected if sea levels and/or mean temperatures go up or down (as they did historically, e.g. Little Ice Age or [Younger Dryas]. (en.wikipedia.org/wiki/Younger_Dryas). (Note that you don't need to assume that any climate change is "anthropogenic" for this.) Transition Risk - the exposure to legacy assets such as petroleum reserves, coal mines, or natural gas pipelines that will lose value if we are mandated to $\endgroup$
    – Dimitri Vulis
    Commented Jul 18, 2021 at 11:38
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    $\begingroup$ to reduce greenhouse gas emissions (again, you don't need to believe that such a mandate would be a good thing - just what its impact would be). Legal or Liability Risk - not limited to climate change. Suppose, for example, that IBM sells its punch card machines to Nazi Germany who uses IBM products to keep track of Jews to gas. In addition to reputational risk, can IBM get sued for lots of money? Likewise, what if a bank lends money to a corporation engaged in child labor / environment destrucrtion / some other bad behavior - can the bank get sued? $\endgroup$
    – Dimitri Vulis
    Commented Jul 18, 2021 at 11:52
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    $\begingroup$ There are, of course, lots of debates on how these risks should be quantified and reported, e.g. which scenarios should be considered for physical risk, and how can their impact be assessed. Everyone thinks that it would be better if reports from different companies in different jurisdictions were comparable. The Financial Stability Board (FSB) created a task force (TCFD) which created some documents. Now accounting and regulatory bodies (IFRS in EU, FASB & SEC in the U.S., etc) are working on reporting standards that already are or are soon likely to be obligatory for lots of firms. $\endgroup$
    – Dimitri Vulis
    Commented Jul 18, 2021 at 12:02
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    $\begingroup$ valued based on embedded climate risk. One can then optimize a portfolio to minimize climate risks and to maximize the "climate adjusted" P&L rather than regular P&L. Some of the links in my answer discuss the unadjusted P&L from such portfolios is generally meh. $\endgroup$
    – Dimitri Vulis
    Commented Jul 18, 2021 at 12:15

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Here are some resources that I found useful when learning about this subject, in which I'm very interested. (Some may be more general ESG than just just climate.)

Edit: @nick012000 suggested I copy to the answer some additional color that I had in comments.

8 The book Shmatov, Castelli. Quantitative Methods for ESG Finance is also forthcoming.

  • People usually try to quantify 3 kinds of ESG-related risks:

Physical Risk - how will the company be affected if sea levels and/or mean temperatures go up or down (as they did historically, e.g. Little Ice Age or Younger Dryas. (Note that you don't need to assume that any climate change is "anthropogenic" for this.)

Transition Risk - the exposure to legacy assets such as petroleum reserves, coal mines, or natural gas pipelines that will lose value if we are mandated to reduce greenhouse gas emissions (again, you don't need to believe that such a mandate would be a good thing - just what its impact would be).

Legal or Liability Risk - not limited to climate change. Suppose, for example, that IBM sells its punch card machines to Nazi Germany who uses IBM products to keep track of Jews to gas. In addition to reputational risk, can IBM get sued for lots of money? Likewise, what if a bank lends money to a corporation engaged in child labor / environment destrucrtion / some other bad behavior - can the bank get sued?

There are, of course, lots of debates on how these risks should be quantified and reported, e.g. which scenarios should be considered for physical risk, and how can their impact be assessed. Everyone thinks that it would be better if reports from different companies in different jurisdictions were comparable. The Financial Stability Board (FSB) created a task force (TCFD) which created some documents. Now accounting and regulatory bodies (IFRS in EU, FASB & SEC in the U.S., etc) are working on reporting standards that already are or are soon likely to be obligatory for lots of firms.

In addition to single company reporting/accounting, there's been lots of work on using ESG data for portfolio analysis and investments decisions. E.g. Pedersen, Fitzgibbons, Pomorski. Responsible investing: The ESG-efficient frontier (2021). E.g. MSCI. Climate Value-at-Risk E.g. Blackrock's Aladdin Climate combines data from Refinitiv&c with analytics from Rhodium Group, Baringa Partners,&c to produce a "CAV" Climate Adjusted Value, an adjusted market price at which an asset "should" be valued based on embedded climate risk. One can then optimize a portfolio to minimize climate risks and to maximize the "climate adjusted" P&L rather than regular P&L. Some of the links in my answer discuss that the unadjusted P&L from such portfolios is generally meh.

Edit: E.g. Moody's paper connects climate risk with their (former KMV) model for physical probability of default. E.g. Chris Kenyon, Mourad Berrahoui. Climate Change Valuation Adjustment (CCVA). E.g. Michael Barnett, William Brock, Lars Peter Hansen. Pricing Uncertainty Induced by Climate Change.

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    $\begingroup$ +1 That you are ‘very interested’ is a serious understatement 😀 $\endgroup$
    – ir7
    Commented Jul 17, 2021 at 2:03
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    $\begingroup$ Dimitri, that is a serious reference list! +1! $\endgroup$
    – Kermittfrog
    Commented Jul 17, 2021 at 5:42
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    $\begingroup$ thanks! this list is great and offers various perspectives. I liked you last paragraph and was wondering if you had more information related to that (e.g. climate adjusted P&L). I have seen some reports on this, but they do not really discuss the details of the methodology. $\endgroup$
    – AK88
    Commented Jul 21, 2021 at 14:32
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    $\begingroup$ Sure, I edited to add a few more recent papers that have some detailed math and aren't obviously nonsensical. $\endgroup$
    – Dimitri Vulis
    Commented Jul 21, 2021 at 15:12

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