The Link Between Physical and Transition Risk

We argue that what is usually referred to as climate ‘transition risk’ can be more usefully decomposed in an expectation part and a variability around this central value. We show that there is a strong inverse relationship between the expectation component of transition costs and the expectation of physical damages, and how this this relationship can be estimated.

Author(s)

Riccardo Rebonato, Dherminder Kainth, Lionel Melin

We argue that what is usually referred to as climate ‘transition risk’ can be more usefully decomposed in an expectation part and a variability around this central value.

We show that there is a strong inverse relationship between the expectation component of transition costs and the expectation of physical damages, and how this relationship can be estimated.

Our results indicate that the uncertainty in transition costs decreases as the abatement policy becomes more aggressive (and physical damage decrease), but remains large as a fraction of the expectation component.

We also show that, with the definition we provide, our transition costs match well the corresponding quantities from the benchmark IPCC scenarios.