Financial markets and climate change: The discount rate
What is the discount rate on large-scale projects to mitigate climate change? This paper, titled Climate Change in Financial Markets, proposes a model that answers this question. In the model, climate change manifests itself through disasters that destroy capital.
Massive Damage —Fire In Canadian Forests
Pollution Location —Most Polluted City In The World
The probability of those disasters is endogenous and grows with anthropogenic emissions that evolve with new investments. The author shows that large-scale projects or policies aimed at abating climate change should be discounted with a rate significantly lower than the market rate, though this rate is increasing over time. The paper also outlines the additional losses the economy will incur if the policy does not start immediately but instead awaits several years. Finally, results show that only the transition risks rather than the physical risks can explain the green premium and reconcile the theoretical predictions with historical observations. Author: Maria Gelrud, University of Pennsylvania, The Wharton School.
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