The Impact of Physical Climate Risk on the Valuation of Global Equity

This article examines how physical climate damages (and tipping risks) propagate into the valuation of a global equity portfolio. Under plausible assumptions about weak abatement and the presence of low-threshold climate tipping points, the difference in shareholder value relative to a world without climate damages can exceed 40%, indicating that markets may be materially underpricing physical risk.  Conversely, prompt and robust abatement can hold losses to <10% even if tipping dynamics are present—an implied “benefit” of =30 percentage points in preserved equity value relative to delayed action scenarios.  The analysis stresses that the degree of abatement aggressiveness, the probability and temperature thresholds for tipping elements, and state-dependent discounting (i.e., lower rates in bad times) are the three levers that swing outcomes from “a few percentage points” to >40% valuation impairment.

Technically, the paper embeds physical-risk damages into forward-looking cash-flow and discount-rate assumptions for an equity index, then sweeps scenarios across tipping thresholds and abatement speed.  The authors note that if today’s equity prices already reflected realistic physical-damage paths, valuations would have to imply either extremely strong near-term abatement or negligible macroeconomic output effects from climate change; because neither assumption seems likely, they conclude there is “ample potential for equity revaluation.”  The findings are consistent with macro-damage projections in Nature that, even absent future emissions, the world economy is committed to a ~19% income reduction within ~26 years, with damages potentially ~50% larger when daily variability and extremes are included—context that reinforces the plausibility of large asset-price impacts.  The equity-valuation lens thus translates aggregate damage functions into investor-relevant losses, highlighting capital-market benefits from faster mitigation that curb the >40% downside tail.

From a policy and risk-management perspective, the paper’s “few percent to >40%” span is a sensitivity map for supervisors and asset owners: it shows how abatement policies (e.g., carbon pricing trajectories) and physical-risk governance (e.g., adaptation that reduces damage intensity) can materially shift valuation outcomes by double-digit percentages.  For strategic asset allocation, it suggests hedging and sector tilts that reduce exposure to climate-sensitive cash flows and tipping-point-amplified losses.  Taken together with EDHEC’s parallel synthesis showing that losses could exceed 50% with near tipping points (and <10% under timely abatement), the weight of evidence supports rapid mitigation as a financially prudent strategy.

Riccardo Rebonato, Dherminder Kainth, and Lionel Melin. “The Impact of Physical Climate Risk on the Valuation of Global Equity Assets.” Environmental and Resource Economics 88 (January 2025): 857–894. https://link.springer.com/article/10.1007/s10640-024-00953-z