Climate Risks in Financial Assets

This note reviews the empirical evidence available in the academic literature about the impact of climate-related risks on financial assets. It addresses three main questions: does climate change already affect financial asset returns? What is the potential impact of future climate-related costs on financial asset prices? Do financial markets adequately price in these costs? We find compelling evidence that climate-related events such as hurricanes and droughts – i.e. physical risks – already have a negative impact on both equity and debt instruments through lower payoffs and higher non-performing loans. We also find early evidence that transition costs impact on some financial assets more than others. Evidence on the effects of future climate costs on financial assets indicates that the financial risks associated with them are financially significant, even with conservative estimation methodologies. The magnitude of these risks critically depends on the extent to which investors currently price them in and on potential second-round effects. Several empirical studies point to a lack of awareness about future climate costs by investors, which support the concerns that financial markets currently do not adequately price in climate financial risks.