Journal of Financial Stability Vol. 63 2022
Climate change financial risks: Implications for asset pricing and interest rates
Abstract
In addition to tail macroeconomic events (e.g. wars, financial crises and pandemics), climate change poses a threat to financial stability — with extreme climatic events increasing in frequency and intensity and policy risks putting pressure on asset valuations. We study the effect of a changing climate on asset prices and interest rates through the lens of a dynamic CAPM with rare disasters, time-varying risk and recursive preferences. In our model, a changing climate makes tail events more frequent and less predictable, increasing the premium of climate risk; interestingly, this change may not be fully reflected in the overall market risk premium that includes both components of risk: macroeconomic and environmental. Our results also support the hypothesis of a declining real rate of interest as the planet warms, while the increasing risk of climate policy reduces the participation of brown assets in the market portfolio.
- DOI
- 10.1016/j.jfs.2022.101061
- Volume
- 63
- Pages
- 101061
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref