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

We estimate how the value of a hypothetical global equity index can be affected by physical climate damage for different degrees of aggressiveness of the abatement policy. We find that the magnitude of the difference in shareholder equity valuation with respect to a world without climate damages ranges from a few percentage points to over 40% depending on: the aggressiveness of the abatement policy (the slower the abatement, the greater the difference); the presence of tipping points with relatively low threshold temperatures; and the extent to which rates will decline in states of low consumption (of economic distress). This leaves open the question of the extent to which these differences in valuation are already embedded in equity market prices. We argue that current valuations appear to imply either a very strong and effective abatement action, or that climate change will have a negligible effect on economic output. Since neither assumption should be considered a very likely scenario, we conclude that there is ample potential for equity revaluation.