Climate Scenarios
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Why State-Dependent Discounting Matters for Climate-Sensitive Securities
The Journal of Portfolio Management February 2025, 51 ( 4) 210 - 225
Author(s)
Riccardo Rebonato
Valuing securities requires projecting expected cashflows and discounting them. We show that accounting for the dependence of the discounting factor on the state of the economy (the “risk premium”) is important in the case of climate-sensitive assets. We provide a simplified expression for the state-dependent discount factor that, when applied to bond-like or equity-like cashflows, can recover both the equity risk premium and the level of rates. Our findings can complement traditional discounted cash flow valuation models, in which discounting is at most time dependent but typically not state dependent.