Physical Climate Risk Research Articles

Farmers’ perceptions of severe climate risks and adaptation interventions in indigenous communities in northern Ghana

Perceptions of climate change are widely studied and documented. However, understandings of conceptions and experiences of severe climate risks in indigenous farming communities are insufficient. This research respond to that knowledge gap with evidence from selected indigenous farming communities in northern Ghana through a mixed-method approach. Results from the empirical data show that farmers perceive severe climate risk to mean livelihood disruption throughout the season, unproductive farmlands, ineffective adaptation and inability to break even. The logistic regression estimates show that gender, marital status, livelihood activity and ecological zone are all influential factors that are likely to predict farmers’ perceptions of severe climate risk. Farmers in northern Ghana experience severe physical climate risks such as extreme droughts, extreme temperatures, severe heatwaves, frequent floods and severe water stress. To mitigate severe physical climate risks and disasters, individual farmers implement indigenous adaptation strategies such as livelihood diversification, construction of hand-dug wells in farms, migration, building of mounds or ridges, and early marriage of young girls. Collectively, farming communities culturally utilize animal sacrifices and spiritual incantations to invoke rains to address prolonged droughts. Understanding severe climate risks and their determinants will provide good policy guidelines for early warning systems to sustainably improve livelihood and food security in resource-constrained communities.

Can climate-related risks increase audit fees?–Evidence from China

In this study, we investigate whether the audit fees would be affected by the firms’ climate-related risks. Using physical climate risks and transition climate risks indicators, we find that climate-related risks can significantly raise audit fees, and this finding still robustness on instrumental variables, replacing audit fees measure, and firm fixed effects model. Furthermore, potential mechanism demonstrates that climate-related risks increase audit fees by the media attention. Finally, the further analysis reveals that the energy firms, state-owned firms and large firms with climate-related risks have a more significant impact on audit fees than non-energy firms, non-state-owned firms and small firms.

Dissecting climate risks: Are they reflected in stock prices?

We provide first-time evidence on whether market-wide physical or transition climate risks are priced in U.S. stocks. Textual and narrative analysis of Reuters climate-change news over January 1st 2000 – December 31st 2018 uncovers four novel risk measures related to natural disasters, global warming, international summits, and U.S. climate policy, respectively. Only the climate-policy factor is priced, especially post-2012. The documented risk premium is consistent with investors hedging the imminent transition risks from government intervention, rather than the direct risks from climate change itself.

Non-banks contagion and the uneven mitigation of climate risk

This paper develops a framework for the short-term modelling of market risk and shock propagation in the investment funds sector, including bi-layer contagion effects through funds’ cross-holdings and overlapping exposures. Our work tackles chiefly climate risk, with a first-of-its-kind dual view of transition and physical climate risk exposures at the fund level. So far, while fund managers communicate more aggressively about their awareness of climate risk, it is still poorly assessed. Our analysis shows that the topology of the fund network matters and that both contagion channels are critical in its study. A stress test based on granular short-term transition shocks suggests that the differentiated integration of sustainability information by funds has made network amplification less likely, although first-round losses can be material. On the other hand, there is room for fund managers and regulators to consider physical risk better, and mitigate the second-round effects it induces, as these are less efficiently absorbed by investment funds. Improving transparency and setting relevant industry standards in this context would help mitigate short-term financial stability risks.

Do climate risks influence foreign direct investment inflows to emerging and developing economies?

ABSTRACT Foreign direct investment (FDI) inflows are considered to be an important source of private financing for several emerging markets and developing economies (EMDEs). However, the high susceptibility of these countries to climate change impacts vis-à-vis their developed counterparts may reduce their attractiveness as a favourable destination for FDI inflows. EMDEs with significant exposure to physical climate risks present a higher incidence of financial risks for foreign investors, which may in turn discourage them from locating themselves in such jurisdictions where their profitability and operations could be jeopardized by climate disasters. Given this context, we empirically investigate how physical climate risks influence FDI inflows to 68 EMDEs using data from over two decades, from 1995 to 2017. We contribute to an emerging body of literature that assesses the impact of climate risks on macro-financial variables by focusing specifically on FDI inflows. Although we abstain from making strong causal claims in our paper, we account for endogeneity concerns extensively and our empirical results show that higher climate risks adversely impact FDI inflows to EMDEs. However, we find these negative effects can be mitigated to a significant degree by strengthening financial sector development in the host country, as it increases their capacity to absorb some of these climate risks more effectively. Key policy insights Emerging markets and developing economies (EMDEs) that are more vulnerable and exposed to physical climate risks tend to be less attractive destinations for FDI inflows. Negative effects of physical climate risks on FDI inflows tend to be mitigated in EMDEs with a high degree of financial development. Well-developed, deep, and inclusive financial markets give EMDEs the capacity to absorb and manage various financial risks including those arising from climate change impacts.

Understanding physical climate risks and their implication for community adaptation in the borana zone of southern Ethiopia using mixed-methods research

Pastoralists in the Borana zone of southern Ethiopia are grappling with climatic risks and impacts, and their livelihoods appear to be precarious. The long-term changes in precipitation, temperature and extreme events are under-researched aspects of climate risk in the study area. Climate observations, local people’s experiences, and memories of weather and drought patterns were analysed in this work to better understand the climate risks in the study region and provide actionable knowledge to facilitate adaptations. In southern Ethiopia, the primary drivers of climate risks are rainfall variabilities, rising temperatures, and drought. The annual rainfall variability observed in the study area (20–35%) is greater than the overall estimate for Eastern Africa (15–25%), indicative of a heightened climate risk in this area. Furthermore, seasonal and intra-seasonal rainfall variabilities are being aggravated by rising temperatures, leading to increased frequency and magnitude of extreme events, particularly in the lowland area. These changes, specifically droughts of different intensities occurring every 2–3 years, erode the livelihood of the pastoralists. The lack of consensus among stakeholders as to the causes and aggravating factors of these climate changes impedes adaptation actions. The authors recommend the importance of initiating a participatory platform that will facilitate discussion on climate change to create a common understanding of the problem and relate it to public policy. The use of gridded precipitation and temperature data is recommended in future research to improve the availability of climate information for climate risk management. In addition, the use of mixed methods and local knowledge, as demonstrated in this study, is highly recommended to better understand climate risks, particularly when there is a limited availability and quality of long-time-series climate data.

Climate risks: nexus between green financial policies and fiscal space

ABSTRACT Aimed at preserving firm-level and macro-financial stability against climate-related physical and transition risks, green financial policies are often viewed as complements to fiscal policies. While the latter are aimed directly at an economy-wide state-led green transformation, the former are targeted specifically towards the financial sector. In this context, this article makes two contributions to the climate change/green finance literature. First, it creates a green financial policy intensity index which measures the cumulative number of such policies rolled out by countries from 1995 till 2021. Second, it empirically examines the nexus between the uptake of these policies and fiscal space. Our findings suggest that higher physical and transition climate risks are associated with more green financial policies being undertaken, but only for countries with limited fiscal space or a high fiscal deficit.

A framework to assess multi-hazard physical climate risk for power generation projects from publicly-accessible sources

Demand for information about physical climate risk is growing, particularly for the power generation sector, given its size and pronounced exposure to climate hazards. However, quantifying physical climate risks for a large number of assets remains challenging. Here we introduce a scalable and transparent methodology that enables multi-hazard physical climate risk assessments for any thermal or hydro power generation project. The methodology relies on basic power plant type and geolocation data inputs, publicly-available climate datasets, and hazard- and technology-specific vulnerability factors, to translate hazard severity into generation losses. We apply the methodology to the European Bank for Reconstruction and Development’s early 2021 thermal and hydro power generation portfolios of 80 assets. We show that under the Representative Concentration Pathway 4.5 scenario, those 80 power plants could experience a 4.0-10.9 TWh loss in annual generation (or 1.87-5.07% of total annual maximum generation) by 2030 compared to its baseline losses of 0.70–0.87 TWh (or 0.33–0.41%). One of the largest drivers of the increased risk is rising water temperatures, which is currently overlooked by mainstream climate risk disclosure guidelines.

Carbon allowances amid climate change concerns: Fresh insights from wavelet multiscale analysis

We examine the dynamic nexus between the carbon emission price and climate change concerns using novel measures of alternatively both physical and transitional climate risks. We apply a wavelet coherence approach to European and North American cap-and-trade programs, highlighting strong correlation between carbon prices and transitional climate risks since 2019. We also reveal a positive relationship between carbon prices and physical climate risks before the Paris Agreement, with this relationship becoming negative in February 2022. Our findings show the important role of climate change concerns on the dynamics of the carbon market.

Climate Change, Firm Performance, and Investor Surprises

We link records of firm performance, equity analyst forecast errors, and stock returns around companies’ earnings announcements to firm-specific measures of heat exposure for more than 17,000 firms in 93 countries from 1995 to 2019. We find that increased exposure to extremely high temperatures reduces firms’ revenues and operating income. A one-standard-deviation increase in the number of hot days decreases revenues (operating income) by 0.6% (1.8%) of the average quarterly revenue (operating income). Moreover, we provide evidence that increased heat exposure impacts negatively on firm financial performance relative to analyst predictions and on earnings announcement returns. These findings indicate that capital market participants do not fully anticipate the economic consequences of heat as a first order physical climate risk. This paper was accepted by Colin Mayer, Special Section of Management Science on Business and Climate Change. Funding: N. Pankratz gratefully acknowledges financial support from the French Social Investment Forum and the Principles for Responsible Investment [PhD Research Grant 2017]. Supplemental Material: Data are available at https://doi.org/10.1287/mnsc.2023.4685 .

Climate risks and predictability of the trading volume of gold: Evidence from an INGARCH model

We investigate whether text-based physical or transition climate risks forecast the daily volume of gold trade contracts. Given the count-valued nature of gold volume data, we employ a log-linear Poisson integer-valued generalized autoregressive conditional heteroskedasticity (IN-GARCH) model with a climate-related covariate. We detect that physical risks have a significant predictive power for gold volume at 5- and 22-day-ahead horizons. Additionally, from a full-sample analysis, it emerges that physical risks positively relate with gold volume. Combining these findings, we conclude that gold hedges physical risks at 1-week and 1-month horizons. Similar results hold for platinum and palladium, but not for silver.

Transition risk, physical risk, and the realized volatility of oil and natural gas prices

The climate change-related risks have been classified into two namely physical risk and transition risk based on the losses suffered and the response to mitigate and adapt to the paradigm shift in environmental sustainability. Consequently, we test how much predictive value can be exploited from these components of climate risks if they are observed in the pricing of energy commodities that are known to be among the largest emitters of emissions. We note three findings in our empirical analyses in this regard. First, we establish that climate risk influences the volatility of crude oil and natural gas markets and improves their out-of-sample forecasts. Second, the transition climate risk more accurately predicts the out-of-sample forecasts of energy market volatility than the physical climate risk suggesting that investors respond more to the various policies/programmes/initiatives aimed at mitigating the climate change-related losses and fatalities and adapting to the paradigm shift in environmental sustainability than paying attention to the physical damages associated with climate change. Finally, investors are more likely to derive higher economic gains when climate risk is observed than when it is not and the outcome from transition risk is greater than that of physical risk. We further highlight some implications of our findings for investors and policy makers.

Climate risks and FDI

Climate-related risks have increased in recent decades, both in terms of the frequency of extreme weather events (physical risk) and the implementation of climate-change mitigation policies (transition risk). This paper explores whether multinational firms react to such risks by altering their presence in countries that are more affected. We measure this by examining foreign direct investment (FDI) dynamics at different levels of aggregation as well as at the firm level. We propose a theoretical framework for firm production location choice that explicitly incorporates transition and physical risks. The model predicts a reduction in FDI resulting from both physical and transition risks but an ambiguous interaction effect of these risks with emission productivity. In an extensive empirical analysis, we find some support for model predictions, but overall we do not find consistent evidence for statistically significant effects of physical and transition risks on FDI. However, firm-level evidence suggests that firms that are more exposed to climate risks react more negatively to physical climate risk following Paris Climate Accord. We also find that FDI outflows following extreme weather events from affected countries are smaller for industries with higher emission productivity (greener industries). Our theory and empirical results point to the importance of accounting for heterogeneity in emission productivity when analyzing the effects of climate risks.

Fiduciary Activism From Below: Green Gentrification, Pension Finance, and the Possibility of Just Urban Futures

This article investigates the evolving concept of fiduciary duty and its role in Canadian public sector pension funds’ environmental, social, and governance (ESG) investing practices. It contributes to the literature in the distinct but related fields of environmental gentrification and urban climate finance by bringing fiduciary debates into sharper focus. Engagement with issues surrounding investors’ legal and ethical duties to invest responsibly can contribute to an enhanced understanding of the global and local mechanisms of production and reproduction of environmental and spatial inequalities, as well as strategies for creating more than just urban futures. ESG, a calculative and modelling technique used to manage investment risks, overwhelmingly focuses on physical and financial climate risks (e.g., infrastructure assets and risks associated with regulatory change). This privileges the instrumental, Cartesian view of the environment as severed from its social, historical, and relational character, a perspective that has been thoroughly critiqued in the environmental/ecological gentrification literature. However, ESG investing has also introduced a potentially productive uncertainty in the realm of financial expertise; it forces questions about what it means to invest deferred compensation in the “best interests” of workers and retirees. This article has three interrelated aims. First, it reviews recent trends in environmental gentrification and urban climate finance literature to highlight an emerging but underdeveloped engagement with ESG and fiduciary duty. Second, it shows how the rise of ESG has revealed a vulnerability in the hegemonic profit maximization interpretation of fiduciary duty and invited further, open-ended, critical-theoretical engagements with the concept of the fiduciary and their responsibilities. Finally, it offers the concept of “fiduciary activism from below” to explore how grassroots agency increasingly stages a direct confrontation with corporations, institutional investors, and shareholders in the struggles over urban space and resistance to environmental and infrastructural violence.

Climate uncertainty and information transmissions across the conventional and ESG assets

This paper examines the effect of climate uncertainty on the spillover effects across the European conventional and environmental, social, and governance (ESG) financial markets via novel measures of physical and transitional climate risk proxies obtained from textual analysis. Analyzing daily data for stocks in the MSCI Europe ESG Leaders Index and various Euro based ESG bond indexes over the period January 3, 2014–September 30, 2021, we show that the shock transmissions between the conventional and ESG assets are significantly lower during periods of high climate uncertainty, suggesting that ESG investments can offer conventional investors diversification benefits against climate-driven shocks. Further comparing a forward-looking investment strategy conditional on the level of climate risk against the passive investment strategy, we show that investors who are worried about physical climate risks could utilize ESG equity sector portfolios as a diversification tool against physical climate uncertainty. In contrast, ESG bonds are found to be particularly useful in managing transition risk exposures that are associated with policy uncertainty and/or business transitions with respect to environmental policies. The findings have important implications regarding the role of climate uncertainty as a driver of informational spillovers across the conventional and ESG assets with important insights to manage climate risk exposures.

The Cost of Maladapted Capital: Stock Returns, Physical Climate Risk and Adaptation

The Cost of Maladapted Capital: Stock Returns, Physical Climate Risk and Adaptation

Corporate Bonds and Climate Change Risk

Several industry participants have actively started managing the environmental externalities of their economic activities. As environmental policies become clear(er), the asset prices would likely evolve to drive transition to a low-carbon economy. With this article the authors intend to highlight to investors and portfolio managers the significance and financial materiality of climate change risk to the value of their developed-market corporate-bond portfolios. This article shows that, even though the broader credit market and bond spreads are yet to systematically incorporate the impact of climate policies or the potential for physical climate risk, these risks can have a material impact on the asset value of firms, and that the downside risk is large enough to adversely affect bondholders and other creditors of firms. The authors hope this article will encourage bond investors to take a more active role, along with equity holders and policymakers, in spurring firms onward in the transition to a low-carbon economy.

What Can Machine Learning Teach Us about Australian Climate Risk Disclosures?

There seems to be no agreed taxonomy for climate-related risks. The information in firms’ climate risk disclosures represents a new resource for identifying the priorities and strategies of Australian companies’ management of climate risk. This research surveys 839 companies listed on the Australian Stock Exchange for the presence of climate risk disclosures, identifying 201 disclosures on climate risk. The types of climate risks and the risk management strategies were extracted and evaluated using machine learning. The analysis revealed that Australian firms are focused on acute physical climate risks, followed by market and regulatory risks. The predominant management strategy for these risks was to use a risk reduction approach, rather than avoiding or transferring risk. The analysis showed that key Australian industry sectors, such as materials, banking, insurance, and energy are focusing on different mixtures of risk types, but they are all primarily managing risks through risk-reduction strategies. An underlying driver of climate risk disclosure was composed of the financial implications of climate risk, particularly with respect to acute physical risks. The research showed that emission reductions represent a primary consideration for Australian firms in their disclosures identifying how they are responding to climate risk. Further research using machine learning to evaluate climate risk disclosure should focus on analysing entire climate risk reports for key topics and trends over time.

Physical Climate Risk and Firms’ Adaptation Strategy

Physical climate risks increasingly impact firms. While scholars have investigated how firms mitigate their impact on climate change, we know little about how firms adapt to climate change. I build a novel dataset that compiles information on the adaptation strategies of publicly traded companies across the globe, and merge it with climate science data. Using this dataset, I examine whether, how, and under which conditions firms adapt to physical climate risks. I find that the average adaptation rate across firms and climate risk drivers is 23%. Firms are more likely to engage in risk management as opposed to business strategies. On average, firms facing higher climate risks are more likely to adapt and do so with a broader range of adaptation strategies (which include both risk management and business strategies). The impact of climate risks on firms’ adaptation strategies increases over time, particularly for business strategies. I further examine the mechanism and find that higher level of climate risk increases managers’ risk perceptions, which triggers them to increase their adaptation strategies.

Climate Change and Adaptation in Global Supply-Chain Networks

This paper examines how physical climate risks affect firms' financial performance and operational risk management in global supply-chains. We document that weather shocks at supplier locations reduce the operating performance of suppliers and their customers. Further, customers respond to perceived changes in suppliers' climate-risk exposure: When realized shocks exceed ex-ante expectations, customers are 6-11% more likely to terminate existing supplier-relationships. Consistent with models of experience-based learning, this effect increases with signal strength and repetition, is insensitive to long-term climate projections, and increases with industry competitiveness and decreases with supply-chain integration. Customers subsequently choose replacement suppliers with lower expected climate-risk exposure.