Asset-Level Climate Physical Risk Assessment and Cascading Financial Losses

Abstract

The physical component of climate-related financial risk attracts increasing attention of scholars and practitioners. Yet, science-based and transparent solutions to assess and price climate physical risks are still missing. We provide an asset-level methodology that covers all the steps to compute how climate physical risks trans- late into economic and financial risks for investors. Asset-level shocks are computed conditional to the geolocation of firms’ assets, such as productive plants, their exposure to both chronic and acute impacts (hurricanes), and across any chosen set of IPCC climate scenarios. We illustrate the methodology in an application to the equity portfolios of European investors that are exposed to listed firms owing productive plants located in Mexico. We show that using asset-level data, as opposed to aggregate firm data, can lead to over 53% increase in estimated portfolio losses.

Keywords: Geolocalized physical assets, climate physical risk, cascading losses, equity value adjustment, Climate Discount Dividend Model, portfolio losses.

JEL Classification: G00, G32, Q54