Measuring climate-related and environmental risks for equities.

Abstract

Financial regulators and investors are increasingly concerned about the effects of climate change on investments and seek to capture the climate-related and environmental risks of investments. Whilst energy companies have attracted most of the attention due to the contribution of the Energy sector to environmental degradation, climate-related and environmental risks actually affect companies in every sector. In this paper, we propose novel measures termed as climate Value-at-Risk (VaR) and climate Expected Shortfall (ES) that capture the risk attributed to transition risk factors proxied by environmental scores. We compare the average ratio of climate VaR and ES to total risk in various equity sectors, which enables us to identify the sectors in which climate and environmental risk factors contribute most to the total risk. Our analysis considers different risk measurements and various significance levels. Our findings show heterogeneity in sensitivity to climate and environmental risk factors in various sectors. The Health Care sector is the least cost-effective in reducing climate-related and environmental risks, and the Energy sector benefits most from improving the firms' environmental scores.