Investors face a growing risk that climate change will result in a sudden loss of value, with existing portfolio models often falling short, according to an analysis by Markus Müller, chief investment officer for ESG at Deutsche Bank.
“The temptation is to assume that the effects” of global heating “will accumulate only gradually,” he said in a client note. “However, this isn’t guaranteed.”
The Deutsche Bank executive says investors need to prepare themselves for the unanticipated consequences of “fat-tail” risks associated with climate change. Though such events are deemed unlikely, their fallout can be catastrophic. At the same time, academic research suggests that climate change is a field in which such outcomes are “dangerously under-explored.”
The trajectory of climate change is proving far from linear, as the planet moves closer to a number of so-called tipping points. If breached, the physical effects of climate change could suddenly and dramatically worsen, scientists have repeatedly warned.
In a recent client note, analysts at Jefferies said investors “may not be using the most up-to-date and relevant climate models” to help them assess the risks ahead.
Müller says conventional financial models have so far struggled to handle so-called fat-tail events, with the market meltdown of 2008 standing out as a notable example. Climate change brings with it four distinct risk categories, namely physical, transition, liability and contagion risk, he said.
“The relative importance of these different sorts of risk will change over time,” Müller said.
Given the current understanding of how climate change will play out, it looks as if transition risk — which can come in the form of changing regulations, technologies and
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