Contribution of the course to the overall degree programme goals
This course complements the LM Program in Economics and Finance by providing some instruments to help future practitioners in economics and finance to understand the challenges for finance arising from climate change. The course aims to provide students with operational understanding of metrics to assess climate-related risks and opportunities in financial investments.
Climate change and its mitigation confronts financial institutions with new types of risks and opportunities. Financial institutions need new specific knowledge to understand and manage these risks and to be compliant with developing standards and requirements. This course aims to provide an introduction to this exciting and challenging new field.
In the wake of the 2015 Paris Agreement on Climate Change there has been growing attention by financial supervisors and central bankers on the potential implications of climate risk for financial stability. In particular, the European Commission have set out initiatives to improve the climate risk disclosure, create a taxonomy of sustainable assets. Most financial supervisors and central banks acknowledge today that “climate-related risks are a source of financial risk and that it is in their mandates to ensure the financial system is resilient to these risks.”.
As a result, practitioners of both public and private financial institutions are increasingly interested in 1) investment opportunities aligned with climate mitigation objectives and 2) implications for risk management of both climate-induced physical risk and policy risks associated with the transition to the low carbon economy.
Expected learning outcomes
Understanding of the key notions for climate-related financial risk.
Ability to discuss the main challenges for financial practitioners arising from climate change.
Basic knowledge of classification of economic activities in relation to climate risk.
Ability to perform basic data analysis related to financial risk at the firm level.
Ability to compute risk measures for climate-related financial risk as presented in class and applications to financial portfolios of securities.
Successful completion on Mathematic modules
Ability to carry out basic data analysis using electronic spreadsheet or programming languages
Recall of basic notions on risk metrics and coherent risk metrics: Value at Risk, Expected Shortfall. Conceptual challenges to risk metrics in the context of climate change and the low carbon transition.
Main results of IPCC reports and implications for finance. Climate mitigation versus adaptation. Global warming: averages versus extreme values. Climate-related financial risk. Transmission channels of climate-related risk into financial portfolios.
Climate economics. Notions of carbon budget, social cost of carbon. Analysis of Nordhaus’s DICE model assumptions, critiques by Pindyke and Weitzman. The debate of the discount factor.
Climate-related financial risk: physical risk versus transition risk. Physical risk: classification of climate-related hazards. Methods to estimate exposure to physical risks. Examples, case studies, available estimates of losses related to physical risk.
Recent developments in policy and practice relevant to financial risk and investment objectives. The EU Taxonomy of Sustainable Finance. Towards climate stress-tests: objectives and challenges at key financial actors such as ECB, EIOPA, EBA and other supervisors.
Transition risk. Value chain of energy and green-house gas (GHG) emissions throughout economic sectors. GHG accounting methods Scope 1-2-3 and their limitations for climate risk assessment. ESG ratings and their limitation for climate risk assessment. Climate risk assessment requires analysis of firms’ technology profile.
Classifications of economic activities in relation to climate risk. Traditional classifications for national accounting (ESA2010, NAICS, NACE Rev2) and their limitations for climate risk disclosure. Classification method of Climate Policy Relevant Sectors (CPRS). Example: analysis of exposures to CPRS across EU financial sectors.
Working with climate-relevant data: GHG emissions data at sector level and firm level. ESG data versus climate-relevant data. Working with information from main data providers: BvD, Bloomberg and Thomson Reuters.
Modern generation Integrated Assessment Models (IAM), absence of (explicit) financial sector in IAM, and limitations for transition scenarios. From climate policy scenarios to financial risk: how to leverage on the knowledge from IAM trajectories to derive financial shocks from trajectories.
Risk metrics (Value at Risk and Expected Shortfall) adjusted for climate policy shocks: scenario-conditional Climate Value at Risk. Application to example securities portfolios.
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