Climate Scenarios

Environmental and Resource Economics

The authors estimate how the value of a hypothetical global equity index can be affected by physical climate damage for different degrees of aggressiveness of the abatement policy. 

They find that the magnitude of the difference in shareholder equity valuation with respect to a world without climate damages ranges from a few percentage points to over 40% depending on: 

• the aggressiveness of the abatement policy (the slower the abatement, the greater the difference);
• the presence of tipping points with relatively low threshold temperatures;
• and the extent to which rates will decline in states of low consumption (of economic distress). 

This leaves open the question of the extent to which these differences in valuation are already embedded in equity market prices. They argue that current valuations appear to imply either a very strong and effective abatement action, or that climate change will have a negligible effect on economic output. Since neither assumption should be considered a very likely scenario, we conclude that there is ample potential for equity revaluation.

Environmental and Resource Economics. The authors estimate how the value of a hypothetical global equity index can be affected by physical climate damage for different degrees of aggressiveness of the abatement policy. 

The paper “How to Assign Probabilities to Climate Scenarios” by Riccardo Rebonato, Lionel Melin, and Fangyuan Zhang proposes a novel framework for attributing probabilities to long-term climate scenarios. This responds to a critical shortcoming in existing scenario analysis tools used in financial regulation and investment strategy, which typically lack a probabilistic dimension. The authors argue that without probabilities, scenarios are limited in their ability to inform risk-adjusted decision-making.

Using a large meta-dataset of 5,905 Social Cost of Carbon (SCC) estimates from 207 academic studies, the research applies two complementary methods: one based on expert assessments of carbon pricing, and the other on a maximum-entropy approach that requires minimal prior assumptions. These approaches produce consistent estimates of the likelihood of different climate outcomes by 2100.

The findings are striking. The probability of limiting global warming to 1.5°C is found to be very low, while the median expected temperature increase is around 2.7°C. Perhaps most notably, the paper estimates a 35–40% chance that global temperatures will exceed 3°C, a level associated with a higher likelihood of irreversible climate tipping points. Furthermore, the analysis suggests that the physical damages resulting from such warming may outweigh the economic costs of a low-carbon transition.

To demonstrate the model’s applicability, the authors align their framework with the structure of the Oxford Economics climate scenarios. They find that more than 90% of the probability mass is allocated to scenarios characterized by limited or delayed abatement. This probabilistic insight allows for a more robust evaluation of transition and physical risks across plausible futures.

The study concludes that integrating probabilities into climate scenario analysis is essential for credible stress testing, regulatory planning, and asset valuation. By offering a tractable and transparent method, the authors contribute a significant tool to the development of climate-resilient financial strategies.

The paper “How to Assign Probabilities to Climate Scenarios” by Riccardo Rebonato, Lionel Melin, and Fangyuan Zhang proposes a novel framework for attributing probabilities to long-term climate scenarios. This responds to a critical shortcoming in existing scenario analysis tools used in financial regulation and investment strategy, which typically lack a probabilistic dimension. The authors argue that without probabilities, scenarios are limited in their ability to inform risk-adjusted decision-making.

The EDHEC Climate Institute follows the long-standing research tradition of EDHEC Business School and represents a collective effort to address the pressing challenges of climate change by promoting interdisciplinary research with a more integrated vision, drawing on historical expertise in climate finance while leveraging new complementary fields to produce concrete insights and applications. 

On the trail of the EDHEC-Risk Institute and the EDHEC-Risk Climate Impact Institute, the recently formed EDHEC Climate Institute addresses the diversity of climate change-related issues such as evaluating the financial implications of climate change on equity valuation, assigning probabilities to climate scenarios, integrating high-resolution climate data, assessing decarbonisation and resilience technologies, and discussing transition finance, which is a main driver for climate transition. 

While climate finance often emphasises transition risk, initial work from Riccardo Rebonato highlights the critical importance of physical climate risk, which may have an even greater impact on financial markets. The research shows how physical damage impacts equity valuations under different policy and climate scenarios, revealing potential market mispricing. It underscores the need to better incorporate physical risks into financial models, as current valuations may miss their true economic effects. 

Climate risk assessments often use separate scenarios that focus on extreme transition risk or severe physical risk, neglecting the probabilistic interplay between these outcomes. The study by Riccardo Rebonato proposes methods to attach probabilities of various emission abatement scenarios, integrating technological, fiscal, and policy feasibility into the analysis. This research also highlights a low probability of achieving the Paris Agreement target and the need for a more realistic alignment between economic recommendations and policy action. 

Hurricanes devastate coastal cities, droughts cripple agricultural plains and wildfires ravage forests. Climate change impacts are localised, yet global averages fail to reflect these disparities. Climate risk assessments must take advantage of granular spatial data surpassing their complexity and inherent computational challenges. Such data enables precise identification of geo-sectorial vulnerabilities, allowing cities and businesses to allocate resources, develop targeted adaptation strategies and build resilience. This is what Nicolas Schneider explores in his work on how advances in data and modelling are transforming climate risk management, ensuring investors are equipped to account for localised risks and grasp the true economic cost of adaptation. 

On the latter, understanding the technologies behind resilience and decarbonisation measures is a game changer. Ambitious goals and net-zero pledges dominate the conversation but remain vague or lack actionable pathways. Focusing on the technological possibilities allows one to move beyond abstract commitments. This is illustrated by the infraTech 2050 initiative, which is a science-driven approach offering systematic evaluation of technologies and strategies for decarbonising and strengthening resilience of 101 infrastructure asset subclasses with granular information. The article by Conor Hubert, Rob Arnold and Nishtha Manocha illustrates this with a concrete example on data infrastructure, a critical backbone for modern economies. 

The successful adoption of resilience and decarbonisation technologies depends on effective regulatory mechanisms. Therefore, transition finance is critical to decarbonisation. In this issue, Frédéric Ducoulombier assesses the role given to transition finance in the EU Sustainable Finance Framework and highlights the gaps and flaws that hinder transition investment. He then draws on industry best practices and recent regulatory developments to propose key areas for reform aimed at improving transition finance integration.

This special issue of EDHEC Research Insights introduces the newly established EDHEC Climate Institute (ECI), which builds on EDHEC’s legacy in climate finance to address the broader and increasingly urgent challenges of climate change. Through interdisciplinary research, ECI explores critical topics such as physical and transition risks, probabilistic climate scenario modelling, spatially detailed risk assessments, and the technological and regulatory pathways for decarbonisation and resilience. Articles in this issue showcase innovative approaches—from quantifying equity impacts of physical damage to evaluating infrastructure technologies—while also critiquing and suggesting improvements to current EU transition finance frameworks.

We first examine how climate risks—both physical and transitional—affect equity valuation, revealing potential market mispricings.

We then introduce a probabilistic framework for climate scenarios, emphasizing the low probability of achieving the Paris Agreement target and the need for a more realistic alignment between economic recommendations and policy action.

Recognizing the localized nature of climate shocks, we explore how granular high-resolution climate data enhances risk assessment, allowing investors to identify sector- and region-specific vulnerabilities.

We also highlight InfraTech 2050, a science-driven initiative systematically evaluating technologies and strategies for decarbonization and resilience across 101 infrastructure asset subclasses, with granular insights into data infrastructure, a key component of modern economies.

Finally, we assess the role of transition finance, identifying gaps in the EU regulatory framework and proposing key reforms to better align investment with climate goals. 

In this EDHEC Climate Institute special issue supplement to Pensions & Investments, we explore climate change’s impact on equity valuation, the need for probabilistic climate scenarios, and transition finance regulation. We also highlight high-resolution climate data for risk assessment and resilience and InfraTech 2050’s role in mitigating transition and physical risks, offering insights for climate-resilient investment strategies.

This research examines the impact of climate change-induced transition costs and physical damages on global equity valuation by pricing equity as the sum of discounted claims on consumption across climate and economic scenarios consistent with different greenhouse gas emissions trajectories.

Methodological Contributions:

This work innovatively combines asset pricing techniques with an upgraded integrated climate economics model. It benefits from three distinctive methodological innovations:

• Full Probabilistic Treatment: We rigorously address the uncertainty inherent in both the physical and economic dimensions of the problem.
• State-Dependent Discounting: We incorporate this crucial but often overlooked aspect of valuation, highlighting its importance.
• Integrated Analysis of Transition Costs and Physical Damages: Our coherent framework contrasts with traditional approaches that analyze these impacts separately and often inconsistently.

The probabilistic treatment is essential because the damages obtained with average climate outcomes are not the same as the average of damages across different climate scenarios. State-dependent discounting is critical, as we demonstrate that the highest climate damages are correlated with economic activity levels, which, in turn, influence prevailing interest rates. A joint treatment of transition costs and physical damages is necessary because these two factors are intimately and inversely related, requiring consistent estimation.

Key Results:

Impact of Abatement Policies

1. A robust abatement policy, i.e., roughly speaking, a policy consistent with the 2°C Paris-Agreement target, can limit downward equity revaluation to 5-to-10%.
2. Conversely, the correction to global equity valuation can be as large as 40% if abatement remains at historic rates, even in the absence of tipping points.

Role of Tipping Points

3. Tipping points exacerbate equity valuation shocks but are not required for substantial equity losses to be incurred.

Importance of Physical Damages

4. When state-dependent discounting is used for valuation, physical damages, even if ‘back-loaded’, are not fully ‘discounted away’, and contribute significantly to the equity valuation.

Conservatism and Limitations:

While estimated revaluations are often more severe than those reported in the literature, the valuation is based on conservative choices. First, modeled losses are limited by the counteracting effect of lower rates in states of reduced economic activity. While this parallels typical actions of monetary authorities, there are practical circumstances that could limit the ability of central banks to adopt such an accommodative stance, e.g., excessive inflation or accumulated public deficits. Second, the analysis is centered around relatively benign functions to map temperature increases to economic damages. Finally, while the analysis treats equity dividends as leveraged claims on consumption, it adopts the lowest leverage used in the literature, which dampens the sensitivity of equity values to economic shocks.

This research examines the impact of climate change-induced transition costs and physical damages on global equity valuation by pricing equity as the sum of discounted claims on consumption across climate and economic scenarios consistent with different greenhouse gas emissions trajectories...