MIT Scenarios for Assessing Climate-Related Financial Risk

[Data Tables: 304 kB]

Climate change has been recognized as a source of risk for the financial sector. The nature of climate change, however, poses some challenges not traditionally encountered by general macro-economic and financial risk assessments. Climate-related risks are slowly evolving and span decades to centuries. This suggests the need for a different approach for evaluating climate-related financial risk than has been used for conventional stress testing of financial institutions. A goal of this paper is to investigate a range of climate policy scenarios to develop various metrics—such as carbon and fossil fuel prices, levels of sectoral production, and estimates of the value of stranded assets associated with a range of energy transitions—that can then be used in further analysis to help identify climate-related financial risk in the specific investment portfolios of individual financial institutions. A second goal is to lay out a set of methods appropriate for evaluating the physical risk of climate change, using an existing set of studies to illustrate challenges and necessary considerations.