●Climate risk become increasingly apparent, climate change poses risks for investors and the financial system
●Climate risks to the financial system and investors are profound and can be divided into two parts(Financial Stability Board, 2017):
1.Transition Risk: Transitioning to a lower-carbon economy may entail extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements related to climate change
2.Physical Risks: resulting from climate change can be event-driven (acute) or longer-term shifts (chronic) in climate patterns
On a Macro Level：
●Climate change is accelerating:
1.Of the seventeen warmest measured years since recordkeeping began in 1880, sixteen have occurred since 2001.
2.The rising temperature, climbing sea levels and the retreat of ice sheets and glaciers, and the increasing frequency of droughts and floods reflect a changing climate and increasing atmospheric carbon levels.
●Policymakers and institutional investors worldwide are increasingly concerned about the impact of climate change risks:
- UN Foundation Investor Summit on Climate Risk remarked:
- “. . . investors need to know how the impacts of climate change can affect specific companies, sectors and financial markets as a whole.”
●Corporations that need to balance between long-term sustainability and short-time high-level profits are central participants in the financial system
- Companies can be affected by climate risk in many ways:
a.Supply chain disruptions and asset damages caused by natural disasters (e.g., hurricanes, floods)
b.Productivity and demand decline due to physical impacts (e.g., sea-level rise, extreme warm/cold)
c.Risks and opportunities related to the transition to a lower-carbon economy (e.g., emission regulation, technology innovation, renewable energy, reputation)
●Do Climate Risk Shocks Affect Firm’s Perception of Climate Physical and Regulatory Risk
- Macroclimate risk shocks (constructed from mainstream media: e.g. WSJ or other public attention proxies)
- Firms’ perception of climate physical and regulation risk (constructed from firm’s statement: e.g. earnings conference call transcript or other possible data sources)
- Macroclimate risk shock: shocks from physical climate risk vs shocks from climate regulatory risk
- Cross-sectional analysis： Green firms vs Brown firms →Firm valuation & Characteristics
●Investors gradually recognised the decisive position of climate risks in recent years (Krueger et al.,2020; Painter,2020; Bolton and Kacperczyk,2021; Faccini et al.,2021)
- Institutional investors are increasingly following the greenhouse gas emissions of listed firms
- 88% of the clients of BlackRock, the world’s largest asset manager, rank the environment as “the priority most in focus” among ESG criteria (BlackRock, 2020)
- Climate risks, either be categorized into physical or transition risks, might potentially affect the behavior of many institutional investors(e.g., investment management clients, pension beneficiaries, and shareholders)
- Climate risk also provides investment opportunities for portfolio companies and their institutional investors.
●Recent literature has progressed adequately in understanding the effects of climate change on asset prices and firms’ performance(Engle et al., 2020; Bolton et al., 2021; Faccini et al.,2021; Ilhan et al., 2021; Sautner et al., 2021; Li and Yu, 2021)
- Help to understand the empirical relationship between climate change and asset prices.
- Provide practical explanations of how to use financial markets to hedge Macroclimate risks.
- Use Textual and narrative analysis(From mainstream media) to specify the Macroclimate risk shock.
- Explore the correlation between climate change exposure and carbon Intensity or ESG Rating
- Use Textual and narrative analysis(From firms’ statements) to identify the Microclimate risk shock
- Confirm Microclimate risk shock can affect firms’ performance depending on the climate shock’s type and time.
●Several various classifications of climate risks are potentially priced in asset markets, and these multiple risks often do not materialize at one time(Giglio et al., 2021a)
- In general, climate risks can be divided into physical risks and transition risks(Financial Stability Board, 2017)
- Physical risks of climate directly affect changes in the environment on economic activity
e.g. Hurricane, Tsunami
- Transition risks cover an extensive range of influences on firms’ operations and business models, potentially transferring to a low-carbon economy
e.g. Carbon tax, Technological advances
●Response to physical and transition risks could be the threat or opportunity in asset markets(In et al., 2019; Pástor et al., 2020; Görgen et al., 2020; Ilhan et al., 2021; Ardia et al., 2020; Pástor et al. 2022; Aswani et al., 2022)
- Different firms may be positively or negatively related to various climate risks.
- e.g. Coal companies might suffer from transition risks; renewable energy companies would benefit
- According to various climate risk categories and the various exposures of different companies to the risk categories, one of the critical common challenges for all methods of research:
- How climate risks influence financial markets is to develop measures of different firms ‘exposures to both physical and transition climate risks (Giglio et al., 2021a)
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