Climate risk in financial markets: A quantitative framework

Climate change is no longer a distant environmental concern. It is an immediate macro-financial force that is reshaping global economic growth, financial stability, asset returns, and investor behaviour for the coming decades. Lionel Melin, Associate Researcher and Fangyuan Zhang, Senior Research Engineer at EDHEC Climate Institute delve deeper.

The financial impacts of climate change are often misunderstood or incompletely captured by traditional, backward-looking risk models. This article distils the insights of an advanced climate-finance model into implications for policymakers and investors.

Our central finding is clear: with rising temperatures, economic growth slows lastingly, financial uncertainty increases, and investors demand significantly higher compensation for risk.

As a result, even in the absence of catastrophic tipping points, under a 3◦C warming scenario, the  equity risk premium (ERP) rises by c. 15–25%, while the real risk-free rate temporarily declines and valuation multiples permanently recede for risky assets. (...)