Quantifying Severe Climate Risk: An Application to Long-Term Investing

Abstract

Climate change is having an increasing impact on the world, but its potential effects in the long term are often underestimated by financial investors and policymakers. Navigating the upcoming risks and impacts of global warming is critical for prudent long-term investors, or multi-generational investors, and policymakers, particularly in high-impact areas, such as coastal cities. Modelling the economic impacts of climate change is vital to understanding the low-probability, high-impact risks of extreme situations, since these can have non-linear destructive effects. This thesis presents a method of combining climate damage functions for the United States together with extreme sea-level rise and temperature predictions from climate science models. This gives estimates of the major impacts that could occur for which agents with long horizons should prepare. Translating these estimates to potential changes to asset prices allow for simulations of the U.S. economy and tests for tools and policies to best navigate these changes using Monte Carlo simulations. In particular, private equity is analyzed as a potential tool for mitigating these long-term risks caused by climate change. The results should help multi-generational investors and policymakers assess the risks associated with climate change and utilize the deeper understanding of the potential economic damage for critical decision making.