Climate change financial risks: Implications for asset pricing and interest rates

Christos Karydas and Anastasios Xepapadeas

Journal of Financial Stability, 2022, vol. 63, issue C

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.

Keywords: Climate change; Tail events; Time-varying risk; Asset pricing; Interest rates (search for similar items in EconPapers)
JEL-codes: G11 G12 O44 Q51 Q54 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:63:y:2022:i:c:s1572308922000833

DOI: 10.1016/j.jfs.2022.101061

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