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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: The Wiley Finance Series
- Sprache: Englisch
A holistic view on climate risk and practical ways to model and measure it
Advanced Analytical Methods for Climate Risk and ESG Risk Management provides risk management professionals and other interested parties with an introduction to climate risk, a detailed history of climate change, and analytical risk management methods. Readers will gain insight on the potential impact of climate change and learn to apply a concrete three-pronged framework for risk modelling and assessment. The management of climate risk—regardless of the size of the business or of the potential loss—is also considered in detail, with discussions of risk allocation, portfolio optimization, regulatory constraints, and sustainable goal setting.
The development of advanced risk management analytical methods for ESG and climate risk is limited. This book fills a gap by offering a comprehensive review of modelling theory and methods for addressing the accelerating changes to the planet's climate.
- Gain thorough background knowledge of climate science, the history of climate change, and the current political and public policy landscape
- Understand how global climate shifts introduce localized impacts to business
- Identify, measure, and manage financial and operational risks
- Utilize a concrete methodology for stress testing portfolios and accounting for risk
Risk management professionals in financial institutions, along with academics and advanced students of economics and finance, will be grateful for this comprehensive approach to climate and ESG risk. Regulators will also benefit from the thorough considerations outlined in Advanced Analytical Methods for Climate Risk and ESG Risk Management.
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Table of Contents
Cover
Table of Contents
Title Page
Copyright
Dedication
Introduction: Climate Risk and Environmental, Social and Governance Challenges
CHAPTER 1: Introduction to Climate Risk
DIMENSIONS OF CLIMATE RISK
BASIC CONCEPTS OF CLIMATE
CARBON DIOXIDE, GREENHOUSE GASES (GHG), AND AIR POLLUTION
THE SCIENCE OF CLIMATE CHANGE
CLIMATE CHANGE, THE INTERGOVERNMENTAL PANEL ON CLIMATE CHANGE (IPCC) REPORTS, AND SOCIAL CHANGE
REFERENCES
CHAPTER 2: Forces of Nature
THE ASTRONOMICAL THEORY OF CLIMATE CHANGE
THE SUN
THE EARTH
AIR AND WIND
WATER AND ICE
THE CARBON CYCLE
REFERENCES
NOTE
CHAPTER 3: A Brief History of Climate Change
NATURAL DRIVERS OF CLIMATE CHANGE OVER THE AGES
FROZEN EARTH
WARMING AND FREEZING CYCLES AND PERIODIC GLACIATIONS
THE LAST ICE AGE, YOUNGER DRYAS, AND CLIMATE CYCLES
CLIMATE CHANGE IN ANCIENT TIMES
ROMAN WARM PERIOD
THE CLIMATE IN THE DARK AGES
THE MEDIEVAL WARM PERIOD
THE LITTLE ICE AGE
THE INDUSTRIAL REVOLUTION AND MAN‐MADE EFFECTS
TODAY AND TOMORROW
REFERENCES
CHAPTER 4: Science, Politics, and Public Policy
SCIENCE, FACTS, PERCEPTION, SOCIAL INFLUENCE, MISINFORMATION, AND FEAR
BEHAVIORAL ASPECTS OF RISK TAKING AND DECISION MAKING
PERCEPTION AND PLAUSIBILITY OF EVENTS
TRUST, DECEPTION, CREDIBILITY, AND FAKE NEWS
SOCIAL PRESSURE, CONFORMITY, AND MEDIA BIAS
SOCIAL POLARIZATION
OPINION POLARIZATION UNDER SOCIAL PRESSURE AND MEDIA BIAS
SOCIAL PRESSURE, MEDIA BIAS, AND PERCEPTION FOR DIFFERENT GROUPS
CHOICE IMPACT FOR DIFFERENT GROUPS
WHAT'S NEXT? TACKLING THE CLIMATE CHANGE CHALLENGE
REFERENCES
CHAPTER 5: Global Shift in Response to Climate Change
THE SHIFT IN THE GLOBAL ECONOMY IN RESPONSE TO CLIMATE CHANGE
TECHNOLOGY CHANGE: FIRST MOVERS, COMPETITIVE LANDSCAPE, AND ECONOMIC ENVIRONMENTS
CLIMATE RISK UNCERTAINTY IN COMPETITIVE BUSINESS ENVIRONMENTS
INNOVATION AND PRODUCT DYNAMICS
PRODUCT ADOPTION
PRODUCT COMPETITION
MULTIPLE COMPETITOR ENVIRONMENTS
UNCERTAINTY IN COMPETITIVE ENVIRONMENTS
REFERENCES
NOTES
CHAPTER 6: Risk Management for Climate Risk and ESG
OVERVIEW, PURPOSE, SCOPE OF RISK MANAGEMENT, AND GOVERNANCE
RISK IDENTIFICATION, MEASUREMENT, AND MANAGEMENT
REGULATORY ENVIRONMENT AND CLIMATE RISK
OPERATIONAL READINESS AND RESILIENCE FOR CLIMATE‐RELATED EFFECTS
RISK MONITORING AND REPORTING
RISK REPORTING AND ANALYSIS
RESHAPING THE INDUSTRY LANDSCAPE: WINNERS, LOSERS, AND SYNERGIES
SUSTAINABILITY, COMPETITIVE ENVIRONMENT, AND A LEVEL PLAYING FIELD
CLIMATE‐RELATED FINANCIAL DISCLOSURES
CLIMATE RISK FINANCIAL DISCLOSURES
BUILDING A STRESS‐TESTING FRAMEWORK FOR CLIMATE RISK USING THREE CORE PILLARS
REFERENCES
CHAPTER 7: Pillar 1: Competitive Landscape and Climate Risk Scenarios for Stress Testing
ASSESSING THE INDUSTRY AND REGULATORY LANDSCAPE, SYNERGIES, AND COMPLEXITIES OF COMPETITIVE BUSINESS ENVIRONMENTS
SCENARIOS FOR THE GLOBAL ECONOMY: ECONOMIC, BUSINESS, AND CREDIT CYCLES
BUSINESS CYCLES, CREDIT SUPPLY, AND DEMAND
ECONOMIC DRIVERS
ECONOMIC ACTIVITY AND CREDIT DEMAND
THE IMPACT OF LOCAL ECONOMIC CONDITIONS ON GLOBAL OBLIGORS
REFERENCES
CHAPTER 8: Pillar 2: Demand for Credit: Modeling Default Risk and Loss Severity
SUPPLY AND DEMAND FOR CREDIT: EXCESS CREDIT DEMAND
ANALYSIS OF ECONOMIC ACTIVITY
DEFINING KEY CONCEPTS: DEFAULT, LOSS LIKELIHOOD, AND LOSS SEVERITY
CREDIT CORRELATION
REFERENCES
NOTE
CHAPTER 9: Pillar 2: Demand for Credit. Risk Assessment and Credit Risk Ratings
THE PATH TO BUSINESS FAILURE
RISK ASSESSMENT AND CREDIT RISK RATINGS
CREDIT RISK RATINGS
DEFAULT AND LOSS CONCEPTS AND RISK RATINGS
DEFAULT RATE STATISTICS BY RATING CATEGORY
RATING TRANSITION MATRICES
RATING TRANSITIONS AND THE TERM STRUCTURE OF DEFAULT RATES
PORTFOLIO RISK RATING
PORTFOLIO TREND RATING
RISK MANAGEMENT RATING
RATING STABILITY
QUANTIFYING ANALYSTS' PERCEPTION OF CREDIT RISK: A BEHAVIORAL MODEL
REFERENCES
NOTES
CHAPTER 10: Pillar 2: Demand for Credit: The Value of Financial Information
THE VALUE OF FINANCIAL INFORMATION: BALANCE SHEET, INCOME STATEMENT, AND STATEMENT OF CASH FLOWS
THE BALANCE SHEET
THE INCOME STATEMENT
THE STATEMENT OF CASH FLOWS
FINANCIAL INFORMATION AND UNCERTAINTY
CASH LIQUIDITY AND DEBT CAPACITY
CASH SHORTFALL, BUSINESS UNCERTAINTY, AND FINANCIAL DISTRESS
REFERENCES
NOTE
CHAPTER 11: Pillar 2: Demand for Credit: Models of Business Failure
CREDIT RISK MODELS OF BUSINESS FAILURE
MODEL SELECTION
STATISTICAL AND ECONOMETRIC MODELS
CREDIT SCORING AND STATISTICAL DISCRIMINANT ANALYSIS
MODELS OF PROBABILITY OF DEFAULT
NONLINEAR MODELS
STATISTICAL INFERENCE AND BAYESIAN METHODS
MODEL SELECTION CRITERIA: LEAST SQUARES AND LIKELIHOOD METHODS
INFORMATION ENTROPY METHODS AND MODEL SELECTION
A PRIMER ON NEURAL NETWORKS
VALIDATING STATISTICAL MODELS
MEASURING MODEL ACCURACY
A VALIDATION APPROACH FOR QUANTITATIVE MODELS
RESAMPLING
MODEL PERFORMANCE AND BENCHMARKING
REFERENCES
CHAPTER 12: Pillar 2: Structural Models
THE ROLE OF MARKET INFORMATION IN THE PRICING OF RISKY DEBT
OPTIONS PRICING, RANDOMNESS, AND THE NOTION OF LIMIT
OPTIONS PRICING AND STOCHASTIC CALCULUS
ITO STOCHASTIC INTEGRALS, CONVERGENCE, AND THE NOTION OF LIMIT
HEDGING PORTFOLIO RETURNS IN THE LIMIT VS. HEDGING THE LIMIT OF PORTFOLIO CHANGES
RESIDUAL RISK AND VOLATILITY SKEWS
HEDGING STRATEGIES AND RESIDUAL RISK
MODELS AND ASSUMPTIONS
ASSET‐BASED MODELS AND MARKET UNCERTAINTY
FORWARD‐LOOKING, SINGULAR PERTURBATION ANALYSIS
MARKET UNCERTAINTY AND THE VALUATION OF EQUITY AND DEBT
REVISITING THE DEFAULT POINT
THE ROLE OF THE COMPANY'S BORROWING CAPACITY
JOINT DISTRIBUTION OF ASSETS, EQUITY, AND DEBT
UNCERTAINTY, ARBITRAGE, AND EQUITY‐DEBT RELATIONSHIP
REFERENCES
NOTES
CHAPTER 13: Pillar 3: Supply of Credit: Modeling Lender's Behavior and Business Strategies
PORTFOLIO MANAGEMENT
ESTIMATING PORTFOLIO LOSSES
REFERENCES
Acknowledgments
About the Author
Index
End User License Agreement
List of Tables
Chapter 1
TABLE 1.1 Dimensions of climate change
TABLE 1.2 Driving factors for understanding climate change
TABLE 1.3 Global temperature increases for selected shared socio‐economic p...
Chapter 3
TABLE 3.1 Climate history (18000
BC
to 10000
BC
)
TABLE 3.2 Climate history (9,000 to 250
BC
)
TABLE 3.3 Climate history (250
BC
to
AD
2024)
Chapter 4
TABLE 4.1 Changes in the positive and negative populations for positive val...
TABLE 4.2 Changes in the positive and negative populations for negative val...
Chapter 6
TABLE 6.1 Climate risk contributions: physical and transition risks
TABLE 6.2 Transmission channels for different risk types
TABLE 6.3 Impact considerations for key risk types
TABLE 6.4 Focus areas for climate‐related reporting activities
TABLE 6.5 Key areas for data and technology infrastructure
TABLE 6.6 Short‐ and long‐term impact of climate risk for different risks
TABLE 6.7 Key components of the TCFD financial disclosure recommendations a...
TABLE 6.8 Relevant information categories used for assessing and pricing ri...
TABLE 6.9 Information on TCFD disclosures that reflect a sound risk managem...
TABLE 6.10 TCFD financial disclosure recommendations and suggested response...
TABLE 6.11 Basic components of financial disclosures for climate risk
TABLE 6.12 The stress‐testing approach, the three key pillars, and their co...
Chapter 7
TABLE 7.1 Historical US business cycles including expansion and contraction...
TABLE 7.2 Quarterly US (real) GDP growth rate for different industries incl...
Chapter 9
TABLE 9.1 Typical risk rating categories
TABLE 9.2 Illustrative example of financial variables applicable to the cre...
TABLE 9.3 Financial variables applicable to the credit assessment for diffe...
TABLE 9.4 Stylized average 1‐year corporate rating transition matrix over m...
TABLE 9.5 Stylized average marginal default rates for selected risk rating ...
TABLE 9.6 Portfolio risk rating characteristics
TABLE 9.7 Portfolio trend rating characteristics
TABLE 9.8 Risk management rating characteristics
Chapter 10
TABLE 10.1 Any‐Company: the balance sheet ($mm)
TABLE 10.2 Any‐Company: income statement ($mm)
TABLE 10.3 Any‐Company: change in retained earnings ($mm)
TABLE 10.4 Any‐Company: sources and uses of funds ($mm)
TABLE 10.5 Any‐Company: statement of cash flows for operating, investment, ...
TABLE 10.6 Any‐Company: cash flows statement of operating, investing, and f...
Chapter 11
TABLE 11.1 Classification costs
TABLE 11.2 Model selection using normalized : (a) logit model, (b) probit ...
TABLE 11.3 Types of classification errors and costs
TABLE 11.4 Comparison of conditional information entropy ratios for multipl...
Chapter 12
TABLE 12.1 Portfolio rate of change for different time steps : mean rate...
Chapter 13
TABLE 13.1 Contractual cash flows through the life of the asset
TABLE 13.2 Contractual cash flows for a simple loan (or bond)
TABLE 13.3 Expected cash flows for a simple loan (or bond) with default ris...
TABLE 13.4 Discounted cash shortfall and expected credit losses
List of Illustrations
Chapter 1
FIGURE 1.1 Drivers of the astronomical theory of climate change: (a) precess...
Chapter 2
FIGURE 2.1 Longitude and latitude of a point.
FIGURE 2.2 Earth's rotational axis.
FIGURE 2.3 The Earth's orbit.
FIGURE 2.4 The Earth's rotation.
FIGURE 2.5 The Earth's rotation and tilt.
FIGURE 2.6 Drivers of the astronomical theory of climate change: (a) precess...
FIGURE 2.7 The Sun's orbit and variability over time.
FIGURE 2.8 The Earth's core, mantle, crust, and atmosphere.
FIGURE 2.9 Radiation and heat energy budget of the Earth (in W/m
2
). About 34...
FIGURE 2.10 General circulation of the atmosphere.
FIGURE 2.11 General ocean circulation of surface and deep water.
Chapter 4
FIGURE 4.1 (a) Population distribution for frequent changes of opinion ( an...
FIGURE 4.2 (a) group
D
(doubters) – polarized view with negative bias ( and...
Chapter 5
FIGURE 5.1 (a) Contributions of different sources of energy to the world's e...
FIGURE 5.2 Sales of electric vehicles for private transportation.
FIGURE 5.3 Typical S‐shape growth pattern of market share.
FIGURE 5.4 Growth pattern of market share with transitory excess demand.
FIGURE 5.5 Distribution of competitive products for different quality, price...
FIGURE 5.6 Market share for product
P
1
at the end of the product lifecycle (...
Chapter 6
FIGURE 6.1 Risk types and their impact.
FIGURE 6.2 Idealized governance structure for climate risk.
FIGURE 6.3 Potential reshaping of the industry landscape as a result of a tr...
FIGURE 6.4 Key components of a climate risk and ESG disclosure framework.
Chapter 7
FIGURE 7.1 Simplified business and credit cycle stages and drivers.
FIGURE 7.2 US recessions (vertical lines) and normalized quarterly changes i...
FIGURE 7.3 Relationship between changes in economic activity (GDP growth rat...
FIGURE 7.4 Credit cycle and economic activity: Corporate default rate and th...
FIGURE 7.5 GDP contributions over time, including consumption (
C
), private i...
FIGURE 7.6 Largest contributions to carbon emissions and GDP.
FIGURE 7.7 Largest contributions to carbon emissions over time.
FIGURE 7.8 Contributions to carbon emissions for different countries and reg...
FIGURE 7.9 Changes in US population, total workforce, employed civilian popu...
FIGURE 7.10 US unemployment rate and business and credit cycles.
FIGURE 7.11 Changes in disposable income and personal savings over time and ...
FIGURE 7.12 Changes in inflation rate/CPI over time and their relation to ec...
FIGURE 7.13 US fiscal deficits, interest payments, and their relation to eco...
FIGURE 7.14 Relative contribution of C, MB, M1, and M2 to the total money su...
FIGURE 7.15 Credit supply and credit demand curves and shifts due to changes...
FIGURE 7.16 Interest rates for different credit cycles: 3 months, 1 year, 5 ...
FIGURE 7.17 Evolution of equity market indicators (S&P 500) for different cr...
FIGURE 7.18 Credit spreads for different risk ratings and their relation to ...
FIGURE 7.19 Changes in international trade flows.
FIGURE 7.20 Currency exchange rates (in USD per currency unit) for selected ...
Chapter 8
FIGURE 8.1 The ratio of total debt of nonfinancial businesses over gross dom...
FIGURE 8.2 Number of non‐investment grade issuers over multiple business cyc...
FIGURE 8.3 Stylized US corporate default rates over time. The light circle r...
FIGURE 8.4 Differences in the distribution of LGDs for different characteris...
Chapter 9
FIGURE 9.1 Illustrative risk rating system.
FIGURE 9.2 Stylized average 1‐year default rates for different risk rating c...
FIGURE 9.3 Stylized average cumulative default rates for different risk rati...
FIGURE 9.4 An analyst or credit officer judges whether the perceived risk
AB
FIGURE 9.5 Transformed default rates for Equation (9.24) for different ratin...
FIGURE 9.6 Regression parameters for different ratings and time horizons obt...
FIGURE 9.7 Observed logarithm of the odds of default for different ratings (...
Figure 9.8 Regression parameters for Equation (9.30) for different ratings a...
FIGURE 9.9 1‐year average transition rates from Baa3/BBB‐ to any other ratin...
FIGURE 9.10 Credit migration framework: (1) default model; (2) rating migrat...
FIGURE 9.11 Observed 1‐year agency default rates by rating category (symbols...
FIGURE 9.12 Observed 1‐year corporate rating transition rates (logarithmic s...
Chapter 10
FIGURE 10.1 Debt refinancing to reduce short‐term liabilities: (a) single pa...
Chapter 11
FIGURE 11.1 Linearly separable distributions of defaulters (
d
) and non‐defau...
FIGURE 11.2 Nonlinear separable distributions of defaulters (
d
) and non‐defa...
FIGURE 11.3 Linearly separable distributions of defaulters (
d
) and non‐defau...
FIGURE 11.4 Distributions of defaulters (
d
) and non‐defaulters (
n
) along the...
FIGURE 11.5 Comparison of the logit and probit models. Both models are norma...
FIGURE 11.6 Illustrative example of (a) a simple logistic regression, and (b...
FIGURE 11.7 Information entropy as a function of the probability
p
.
FIGURE 11.8 Probit model, logit model, and nested logit regression with a fa...
FIGURE 11.9 Illustrative neural network architecture with three basic layers...
FIGURE 11.10 Typical nonlinear outputs for processing units: (a) hard limite...
FIGURE 11.11 Testing approaches across time (horizontal axis) and across pop...
FIGURE 11.12 Default observations for corporate debt issues: (a) shows aggre...
FIGURE 11.13 Walk‐forward testing approach based on a sample of historical d...
FIGURE 11.14 Separation of populations: non‐defaulters on the left and defau...
FIGURE 11.15 ROC curves based on the hypothetical decision axes and criteria...
FIGURE 11.16 Type I CAP curve. The solid curved line shows the model perform...
FIGURE 11.17 The accuracy ratio is the ratio of area A under the model's CAP...
Chapter 12
FIGURE 12.1 Option‐view of the company's equity as a function of the compa...
FIGURE 12.2 Implied volatility as a function of the option's moneyness for d...
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Introduction: Climate Risk and Environmental, Social and Governance Challenges
Begin Reading
Acknowledgments
About the Author
Index
End User License Agreement
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Advanced Analytical Methods for Climate Risk and ESG Risk Management
A Concrete Approach to Modeling
JORGE R SOBEHART
This edition first published 2024Jorge R Sobehart ©2024
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Introduction: Climate Risk and Environmental, Social and Governance Challenges
The implementation of safe and sound risk management practices is a vital concern for financial institutions. One of the most fundamental problems in risk management is the identification, classification, measurement, and monitoring of the risks faced by the institution.
The aim of this book is to outline a framework for modeling and quantifying different aspects of climate risk and Environmental, Social and Governance (ESG) issues and their impact on risk management practices. Credit risk, market risk, profit and loss risk, asset and liability management risk, reputation risk and conduct risk have historically been thought of as related but different areas. However, the impact of climate risk and ESG, which includes physical and transition (or policy‐driven) risks and social issues affecting potentially all other risk types in the short and long term, suggests that financial risks need to be analyzed on a fully integrated basis. Furthermore, in today's highly competitive financial world, successful risk management and financial engineering call for increasing levels of quantitative expertise, including the ability to effectively apply advanced modeling techniques to complex areas such as climate risk and ESG.
Reliance on models to trade and manage risks carries its own risks. Models are susceptible to errors: from incorrect assumptions about the impact of climate risk and ESG to incorrect descriptions of market interactions and social behavior, to inaccurate descriptions of the evolution of companies in highly competitive environments. Risk models used for climate risk and ESG are often based on or are extensions of methodologies developed for other purposes, such as stress testing for market and credit risk. In practice, model imperfections lead to substantial differences between the way markets behave and the models' implications.
This book introduces basic concepts of risk management, provides a broad treatment of modeling theory and methods, and explores their application to risk management practices. It draws on diverse quantitative disciplines across climate‐related sciences, mathematical modeling, statistics and statistical inference, econometrics, and behavioral finance. This book is directed, first and foremost, to professionals in the financial industry involved in the development, implementation, and stress testing of credit risk management analytics, tools, and systems supporting climate risk and ESG initiatives. Second, it is directed toward risk managers who must evaluate practices and set policies for risk management within their own institutions. Third, it is directed to professionals involved in supervising, and in developing regulatory policies for banks and financial institutions. Given the highly evolving nature of the field of climate risk globally, we deliberately sought to avoid focusing on specific regulatory rules, requirements, or regimes. However, we concentrate on general principles and modeling approaches that will be of interest to practitioners and regulators everywhere. Lastly, the topics we discuss may be of interest to academics, professional auditors, and consultants, who play an important role for financial institutions in reviewing methodologies and providing effective challenge and guidance on industry best practices.
CHAPTER 1Introduction to Climate Risk
DIMENSIONS OF CLIMATE RISK
Climate change, environmental, social and governance (ESG) risks are no longer concepts limited to academic and scientific discussions. These terms have become common topics of conversation across the media, for politicians, policymakers, statesmen, corporations, governments, and regulatory agencies around the world. Currently, the international community is struggling to define appropriate approaches, policies, and treaties that can mitigate the challenges of climate change while keeping a level of healthy growth to support economic prosperity (NGFS, 2020; Smith, 2020; FSB, 2021; IEA, 2021; USDT, 2021).
There are four dimensions to understanding climate change (Table 1.1) and its impact:
the science of climate change
the politics of climate change
the economics of climate change
the social impact of climate change.
As a result of the increased social awareness on climate change issues and continuous media coverage, many people now believe that extreme weather events are occurring more frequently than in the past and that the pace of climate change is accelerating toward a catastrophic tipping point. This view also affects statesmen and policymakers, whose decisions can have significant social and economic consequences. The political, economic, and social consequences of perceived climate change are already tangible. Developed (wealthier) nations want less‐developed (poorer) nations to delay or limit their path to industrialization by reducing their carbon footprint and greenhouse gas emissions. In turn, the less‐developed nations want the developed nations to take the economic burden of fixing the problem they have created in the first place. Other nations want to take advantage of this situation by accelerating their development (resulting in increases in their levels of greenhouse gas emissions), while keeping their status of less‐developed economies to avoid limiting their path to prosperity. These conflicting goals make it difficult for the international community to come to terms with climate change. The debate over these issues often breaks down into strongly polarized views: those who favor a man‐made‐only cause of the observed changes in climate in recent times, and those who favor natural causes due to solar activity, oceanic and atmospheric variability, tectonic and volcanic activity with an important but smaller human contribution.
TABLE 1.1 Dimensions of climate change
Dimension
Description
Chapters in this Book
Science
Scientific evidence of natural and man‐made impact on the environment and climate change (physical risk)
1, 2 and 3
Politics
Policies, regulations, and incentives for transitioning to a low‐carbon economy, which can impact sectors, markets, and consumer behavior (transition risk)
4
Economics
Risks and opportunities derived from corporate and investment strategies, practices, and actions to mitigate physical and transition risks
6–13
Social impact
Social behavior, credibility, trust, social polarization, and their impact on the migration to a low‐carbon economy
4, 5
Given the relevance of these issues, gaining a clear understanding of how and why climate changes, with or without human influence playing a role, is one of the most important issues for society today (Mayewski and White, 2002; Plimer, 2009).
The starting point for any meaningful discussion on the topic is to define the concepts clearly. For example, what is the difference between weather and climate? What does climate change really mean? Are the changes due to natural or man‐made causes?
BASIC CONCEPTS OF CLIMATE
The primary distinctions between weather and climate are the period used to record observations and the geographic extent of these observations. Weather is the behavior of the atmospheric system in a specific region over a short period of time, ordinarily one week, a few days or even a few hours. In contrast, climate is the behavior of the weather over extended periods of time, ranging from seasons to years, decades, centuries, or even millennia, and across extended geographic regions such as continents, subcontinents, or other large regions (NOAA, 2024).
The sciences of meteorology, oceanography, geology, and physical geography have advanced dramatically in the past century, assisted by advances in the systematic collection of local measurements across multiple regions of the globe, satellite imaging, the digitalization of information, and increased computational power. Furthermore, the scientific community has learned a great deal in recent decades about the dynamics of atmospheric and oceanographic phenomena and has constructed (and continues to refine) numerous complex models to simulate the global effects of climate change and the consequences of extreme climate patterns.
These models provide valuable insights into possible climate scenarios, their drivers, and the speed of change. But they also require objective scientific validation through strong evidence that demonstrates that these predictions are reasonably accurate and that the physical models driving these predictions and the data used to calibrate these models are comprehensive and complete. This limitation is a significant challenge for the scientific community, given the synergies and non‐linearities observed in atmospheric and oceanographic phenomena, including complex energy and mass flows, which are exacerbated for long‐term forecasts. Also, many physical and chemical phenomena occurring in the atmosphere, oceans, and continents are poorly represented, and even ignored, in these models, due to their complexity or lack of detailed knowledge.
Furthermore, actual records of weather patterns and climate change recovered from instruments that measure temperature, wind speed, precipitation, atmospheric pressure, and sea levels only extend back into the nineteenth century for the northern hemisphere and cover even shorter periods for the rest of the world. Constructing historical records on climate change requires extensive detective work to stitch different pieces of information into a coherent picture of past events. For example, changes in temperature or the level of CO2 and other gases in the atmosphere over thousands of years can be inferred from the analysis of ice cores drilled around the globe.
When snow falls through the atmosphere and is deposited and compacted into ice in extremely cold regions of the planet (such as Greenland or Antarctica), it traps gases, dissolved minerals and chemicals, dust particles and sediments that can reveal the composition of the atmosphere at that moment in time. If the snow that falls does not melt or evaporate during the year, next year's snow will fall and accumulate on top of the previous year's snow. Over time, the snow layers compress and recrystallize under their own weight, creating ice and trapping small pockets of air, dust, and sediments. Ice cores capture changes in the physical and chemical composition of ice, trapped air bubbles, dust, pollen, and sediments that provide a vivid view of past environments and events, even recording climate changes over relatively short periods of time in great detail. The analysis of ice cores also reveals evidence of past volcanic eruptions, forest wildfires, changes in air humidity and dryness reflected in the composition of the trapped dust particles.
With long climate change records of 800,000 years, 2.7 million years or more available from ice cores and other paleoclimate sources, scientists are beginning to describe the natural processes of climate change, which can provide the theoretical foundations for assessing the extent of human influence on the climate (EPICA, 2004; Plimer, 2009; Voosen, 2017).
The term “climate change” is often misused as a substitute for any global shift in climate patterns that could result in a catastrophic anomaly leading to extreme weather events, such as severe hurricanes, floods, and droughts, or sea levels rising at abnormal rates. However, the climate has changed in the past in response to natural phenomena, including dramatic and sudden shifts. Ice core records confirm that the climate has changed significantly in the past and will likely change in the future. The Earth is a highly complex dynamical system, driven by internal factors (such as ocean‐atmosphere interactions, heat redistribution between the Earth's core and mantle, and tectonic and volcanic activity) and external factors (such as the Sun's electromagnetic radiation, or the gravitational pull from the Sun, the Moon, and other celestial bodies). Furthermore, while natural climate changes were once viewed as moderate shifts against a backdrop of ever‐changing short‐term weather patterns, we now know that there have been several rapid climate change events (RCCE) in the past. These rapid changes shifted the regional and global climate very quickly. The ice core records have demonstrated that RCCEs occurred far more frequently than previously thought. RCCEs are massive reorganizations of the Earth's climate system and were more extreme during glacial times (10,000–70,000 years ago), when the ice sheets in the northern hemisphere provided a positive‐feedback mechanism to amplify the colder climate of these periods. These events do not lessen the impact of human activity on climate but highlight that a simplistic view of greenhouse gas emissions as the single driver of climate change cannot provide accurate predictions and can lead to incorrect economic incentives and policies, with detrimental consequences for society.
Although the impact of human activity on climate is very important, an equally relevant question is how climate shapes the development of human civilizations. Human activity can alter naturally occurring climate changes, and these climate changes can in turn affect human activities and economic prosperity. Climate might be one of the most influential factors shaping human history. Furthermore, climate changes have played a critical role, and even triggered, major breakdowns in societies and civilizations around the world for millennia. The Akkadians, the Egyptians, the Mayans, the Norse, and many other peoples were impacted by climate shifts, rising and falling through history, driven by the whims of Mother Nature.
CARBON DIOXIDE, GREENHOUSE GASES (GHG), AND AIR POLLUTION
Sunlight is primarily radiation in the visible range of the electromagnetic spectrum. Greenhouse gases are transparent to sunlight, which passes through the atmosphere heating the Earth's surface. As the Earth's surface warms, it radiates part of the energy back to the atmosphere in the form of infrared radiation (heat). Greenhouse gases absorb a portion of it. This absorption reduces the amount of energy that escapes back into space, trapping energy in the atmosphere that blankets the Earth's surface. If there was no natural air convection to redistribute the excess energy, the trapped energy (heat) would result in an increase in the air temperature, much like in a typical garden glass greenhouse.
Although most discussions on climate change focus on carbon dioxide (CO2) and other greenhouse gases, water vapor in the atmosphere and clouds are the biggest contributors to the greenhouse effect (representing about 50% and 25%, respectively). Water molecules are far more efficient as greenhouse gases than CO2. However, their concentration is a function of the atmosphere's temperature, and therefore they are not considered external forcings of climate sensitivity. In contrast, gases such as CO2 (which represents about 20% of the greenhouse contributions), nitrous oxides, methane, tropospheric ozone, and CFCs can be added to or removed from the atmosphere independently from temperature and, therefore, are considered external forcings of global temperatures.
Before the Industrial Revolution, water vapor and greenhouse gases in the atmosphere caused the air near the Earth's surface to be warmer (about 14°C) than it would have been in their absence (about ‐19°C) (IPCC, 2007). Since the Industrial Revolution, human activity related to extracting and burning fossil fuels (coal, oil, and natural gas) has increased the amount of greenhouse gases in the atmosphere. This leads to a radiative imbalance that can result in global warming.
Man‐made greenhouse gas emissions are roughly equivalent to 60 billion tons of CO2 (IPCC, 2022c). These emissions include roughly 75% from CO2, 18% from methane, 4% from nitrous oxide, and 2% from CFC gases. Emissions of CO2 come from burning fossil fuels for energy generation to support transportation, manufacturing, heating, and electricity. Additional contributions are from deforestation and industrial processes with CO2 as a byproduct of chemical reactions (e.g. manufacturing cement, steel, aluminum, or fertilizers). Methane emissions come primarily from livestock, crop cultivation, landfills, wastewater, coal, oil, and gas extraction. Nitrous oxide emissions largely come from decomposition of fertilizers.
The Earth's surface absorbs a significant amount of CO2 as part of the natural carbon cycle. CO2 is absorbed by plants, and a fraction is released back when biological matter is digested, burned, or decays. Carbon fixation in photosynthesis or in soil formation (land‐surface carbon sinks) removes about 30% of annual CO2 emissions. The oceans absorbed another 20–30% of emitted CO2 globally. Note, however, that CO2 is only removed from the atmosphere when it is stored in the Earth's crust, the oceans, or the soil through physical or chemical reactions.
In addition to greenhouse gases, air pollution in the form of aerosols can scatter and absorb solar radiation, affecting climate on a large scale. Man‐made contributions of aerosols come primarily from the combustion of fossil fuels and biofuels, and from dust generated from human activities. Aerosols have indirect effects on the Earth's energy budget, typically limiting global warming by reflecting sunlight. However, black carbon in soot or dark dust particles that fall on snow or ice can contribute to global warming by reducing the reflectivity of glaciers and ice sheets (reduced albedo), increasing the amount of the Sun's radiation that is absorbed.
THE SCIENCE OF CLIMATE CHANGE
Determining the human impact on climate requires understanding the natural processes leading to climate change. Without a sound baseline of comparison for natural processes, it is difficult to make definite statements about human influence and man‐made effects. The Earth's climate changed significantly over time long before humans existed, and many of the mechanisms for change are still at play today.
Climate is driven (or forced) by a wide range of internal and external factors working on short‐ and long‐term scales, usually compounding their effects non‐linearly. For example, the inclination of the Earth's orbit around the Sun wobbles and the orbit itself shifts over time, causing changes in the radiation received by the planet from the Sun, changing the Earth's energy and heat balance, and leading to periodic climate changes over 23,000, 41,000, and 100,000 years. Short‐term changes in the energy emitted by the Sun and its redistribution by atmospheric and oceanic circulation can also result in climate changes, as observed during the El Niño Southern Oscillations (ENSO) or during regular solar cycles (about every 11 years), marked by changes in sunspot activity and sporadic electromagnetic energy and mass ejection events. While changes in solar radiation during the regular solar cycles may be weak, changes to the physical and chemical aspects of the atmosphere could have measurable effects. Other short‐term effects have been observed over periods of decades or even hundreds of years, which could be influenced by regular shifts in the position of the Sun as it is pulled by the planets in the solar system (barycenter shifts).
The Earth is a complex system with multiple interacting components (the atmosphere, the oceans, the mantle and land masses, the planet's core) and external driving forces (the Sun's radiation, the gravitational pull from the Sun, the planets, and celestial bodies). Climate is only one subsystem in the Earth's system. No single factor can account for the behavior of the Earth's climate over extended periods of time. Rapid climate change events may be set in motion by a variety of factors reinforcing themselves or canceling out each other's effects.
The Earth's rotation around its axis and its orbit around the Sun change over time due to gravitational interactions with other celestial bodies. In the 1860s, James Croll pioneered the view of an astronomical link between Ice Ages and changes in the Earth's orbit. In the 1920s, Milutin Milankovitch refined this view, introducing three key elements of planetary mechanics that resulted in changes to the magnitude and distribution of the solar radiation hitting the Earth (Strahler, 1973; Buis, 2020). These elements of the Earth's orbit are: (1) axial precession, (2) obliquity, and (3) eccentricity (Figure 1.1). The Earth's axis of rotation is not fixed but shifts over long periods of time (axial precession). Every 23,000 years, the Earth is closer to the Sun in an opposing hemisphere, which results in the precession of the equinoxes as the Earth's axis of rotation shifts direction. The tilt of the Earth's axis of rotation (obliquity) relative to the orbital plane also varies a few degrees (between about 22° and 24.5°) over 41,000 years. The shape of the Earth's orbit (eccentricity) is not fixed and changes from nearly circular to slightly elliptical over a period of about 100,000 years. These three effects impact the amount of solar radiation (insolation) reaching different latitudes on the Earth's surface and are major driving forces for climate change.
FIGURE 1.1 Drivers of the astronomical theory of climate change: (a) precession of the equinoxes (orientation of the Earth's axis of rotation); (b) obliquity (tilt in the Earth's axis of rotation); and (c) eccentricity (changes in the shape of the Earth's orbit).
The regular changes of the Earth's orbit and rotation axis impact solar insolation, which results in changes in atmospheric and oceanic circulation. Furthermore, they affect polar atmospheric and oceanic circulation, as reflected in ice core records. When the ice sheets in the northern hemisphere expand, the polar atmospheric and oceanic circulation is energized, and wind speed increases, as indicated by large changes in dust and sea salt deposits found in ice cores. The polar atmospheric and oceanic circulation cycles seem related to the amount of energy received from the Sun and have been found in marine sediment records and other paleoclimate records. The changes in the Earth's orbit are also associated with changes in the sea level, which is largely controlled by how much water is tied up in ice sheets over land masses. Larger ice sheets result in a lower sea level (Berner and Berner, 1987; Macdougall, 2004).
The differences between the Earth's orbit and its rotation changes and the observed polar circulation cycles from ice cores reflect the time lag effects in the complex climate system, as it takes time for ice sheets to adjust to changes in solar radiation. Also, shorter cycle events about 6,000 years apart (called Heinrich events) reflect massive discharges of (fresh water) icebergs into the North Atlantic, which affect sea level, the relative salinity of the ocean, and oceanic circulation.
Ocean water sinks when it is dense; and the saltier and colder, the denser it becomes. Water in the North Atlantic is not only cold but also salty (saline), resulting in significant amounts of dense water sinking to great depths in the ocean, pushing warmer and less salty water out of its way. As winds blowing from east to west across the equator transport humidity, they make the Atlantic more saline. In addition, waters flowing from the Mediterranean into the Atlantic are also more saline. The stream of cold and salty water sinking in the North Atlantic acts as a “conveyor belt” that drives ocean circulation. The water stream eventually warms up and surfaces from the ocean depths in the long return flow, sending heat from the tropics up along the east coast of North America toward Europe and higher latitudes (the Gulf Stream), closing the circulation loop. The Atlantic thermohaline circulation (conveyor belt) drives climate in the northern hemisphere, and did shut off in the past, leading to dramatic changes in global climate (Berner and Berner, 1987).
The mechanisms for climate forcing described above become even more complex when we introduce the impact of air pollutants (dust and particles in the atmosphere) and greenhouse gases (water vapor in clouds, carbon dioxide (CO2), methane, and other gases) that can change the energy balance of the atmosphere.
Although significant progress has been made in recent decades in our understanding of climate, scientists are still debating the fundamental mechanisms for global atmospheric and oceanic circulation and the non‐linearities and delayed effects in the complex climate system. Table 1.2 summarizes the drivers of observed climate changes.
TABLE 1.2 Driving factors for understanding climate change
Contribution
Driving Factor
Physical effects
Earth's orbital cycles
Precession
Obliquity
Eccentricity
Changes to ice sheets
Oscillations in atmospheric and oceanic circulation
Variations in the radiation received from the Sun
Changes to the carbon cycle between oceans, atmosphere, and land (soil)
Changes in heat, energy, and mass transfer to the oceans and atmosphere due to tectonic and volcanic activity
Aerosols and atmospheric pollutants
Changes in the concentration of dust, sea salt, acids, aerosols, and other pollutants in the atmosphere
Natural and man‐made
Greenhouse gases
Changes in greenhouse gases in the atmosphere (including water vapor in clouds, carbon dioxide (CO
2
), methane, nitrous oxide, etc.)
Natural and man‐made
CLIMATE CHANGE, THE INTERGOVERNMENTAL PANEL ON CLIMATE CHANGE (IPCC) REPORTS, AND SOCIAL CHANGE
Although the debate on climate change is primarily driven by statesmen, politicians, and policymakers, the scientific community has provided evidence and arguments to clarify erroneous concepts on climate change and help support adequate policy decisions.
Since 1988, the Intergovernmental Panel on Climate Change (IPCC) has taken on the role of evaluating the technical and scientific merits of climate change information and providing regular assessments. The IPCC is an intergovernmental body of the United Nations, established by the World Meteorological Organization (WMO) and the United Nations Environment Program (UNEP). The member states elect a bureau of scientists to govern the IPCC.
The IPCC does not conduct original research on climate change. It prepares reports on special topics and produces methodologies that can help countries estimate their greenhouse gas emissions. The IPCC has released six assessments and numerous reports reflecting growing evidence for climate change and its relation to human activity (IPCC, 2007, 2018, 2020, 2021a, 2021b, 2021c, 2022a, 2022b, 2022c). The IPCC includes working groups of scientific and technical experts from different fields, and their assessments and reports are expected to reflect an objective and dispassionate view, obtained by consensus of its participants (Mayewski and White, 2002).
The IPCC's sixth assessment report (AR6) (IPCC, 2022c) includes scientific, technical, and socio‐economic information concerning climate change. The latest assessment shares many of the arguments of earlier assessments. According to the assessment, the main source of the increase in global warming is primarily due to the increase in CO2 emissions that “likely” or “very likely” will exceed 1.5°C under higher emission scenarios. Table 1.3 shows the estimated increases in global temperatures for the period 2040–2060 for different shared socio‐economic pathways (SSPs), which are climate change scenarios projected up to 2100 as defined in AR6. SSPs are used to derive greenhouse gas emissions scenarios with different climate policies.
Some headline statements derived from AR6 include:
Human activities (through greenhouse gas emissions) have unequivocally caused global warming, with global surface temperature reaching 1.1°C above the 1850–1900 average temperature.
Global greenhouse gas emissions have continued to increase.
Continued greenhouse gas emissions will lead to increasing global warming.
Deep, rapid, and sustained reductions in greenhouse gas emissions would lead to a discernible slowdown in global warming within around two decades.
Climate change is a threat to human well‐being and planetary health.
TABLE 1.3 Global temperature increases for selected shared socio‐economic pathways (SSPs)
SSP
Scenario
Estimated Warming (2040–2060)
SSP1 1.9
Very low GHG emissions: CO
2
emissions cut to net zero around 2050
1.6°C
SSP2 4.5
Intermediate GHG emissions: CO
2
emissions around current levels until 2050, then falling
2.0°C
SSP5 8.5
Very high GHG emissions: CO
2
emissions triple by 2075
2.4°C
Notice that atmospheric concentrations of carbon dioxide, methane, nitrous oxide, and other gases have increased significantly since pre‐industrial times. Many greenhouse gases have a positive radiative forcing on climate (warming effect) and can remain in the atmosphere for decades. In contrast, man‐made aerosols from fossil fuels and forest fire burning can have a negative radiative forcing (cooling effect) but they do not remain long in the atmosphere.
The IPCC report acknowledges that there is significant annual variability in weather patterns and severity but argues that aggregated temperature records since the 1850s (reflecting a range of data quality and measurement precision issues) show an overall systemic increase in global temperatures. Also, variable natural climate events, such as solar variability or volcanic activity, can make the detection of human influence more difficult to estimate. Regardless of these effects, models suggest climate will continue to change. Overall warming will be the result of an increase in the frequency of hot days and a decrease in the frequency of cold days. The increase in global temperature will result in the thermal expansion of the oceans and melting of ice sheets and glaciers, and sea levels will rise. Early model simulations also suggested a reduction in the strength of the Atlantic thermohaline circulation (conveyor belt), which will have the opposite effect, leading to colder weather in the northern hemisphere.
Although existing models are very valuable to gain insight into possible scenarios for climate change, there is still significant uncertainty in these models to provide the level of comfort required for taking drastic decisions to reduce carbon emissions that can severely affect a country's economic stability and society's wellbeing. For example, capturing the long‐term effects of solar radiation variability, clouds, sea ice and ice sheet dynamics, vegetation, carbon sequestration in the deep ocean and land (i.e., seashell and soil formation) and non‐linear interactions between the atmosphere, oceans and underwater volcanic activity will require further investigation. True scientific discourse demands a dose of healthy skepticism and strong debate on the merits of model assumptions and economic decisions that can affect society.
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CHAPTER 2Forces of Nature
THE ASTRONOMICAL THEORY OF CLIMATE CHANGE
Debate on climate change has renewed the interest in the field of environmental sciences, which focus on environmental problems caused primarily by man, and in earth sciences and physical geography, which focus on physical drivers of land, ocean, and atmospheric changes. The first step in understanding climate change is to learn more about the processes driving our physical environment. We start by reviewing key concepts in earth sciences and physical geography (Strahler, 1973; Millero, 1996; Prager and Earle, 2000; Mathez and Webster, 2004).
At first blush, the Earth can be viewed as a spherical planet, although its shape is more like an oblate ellipsoid compressed slightly along the polar axis and made to bulge along the equator. The oblateness of the Earth measures the flattening of the poles and is defined as the difference between Earth's equatorial radius and the polar radius (roughly 27 miles) divided by the equatorial radius (about 7,927 miles). That is, Earth's polar radius is roughly 1/300 (or 3.3%) shorter than the equatorial radius. Earth's oblateness is primarily attributed to the Earth's rotation and the somewhat plastic nature of the Earth.
The spinning of the Earth around its axis defines two nature points, the north, and south geographic poles. These points define a geographic grid of intersecting north‐south lines or meridians. The Earth's spinning also defines a set of lines running parallel to the equator or parallels.
The location of any point on the Earth's surface can be measured along meridians and parallels. Taking a specific meridian as a reference line, meridian arcs can be measured eastwards (E) or westwards (W) of any point. More precisely, the longitude of an arbitrary point on the Earth's surface can be defined as the arc (measured in degrees) between the selected point and the prime meridian. The generally accepted prime meridian is the one that passes through the Royal Observatory of Greenwich in the United Kingdom (0° longitude).
Knowledge of the longitude of a point only cannot tell us its exact location because it applies to all points in the meridian. To determine the exact location of a point, a second measure is needed: latitude. The latitude of a point on the Earth's surface can be measured northwards (N) or southwards (S) as the arc (also measured in degrees) of a meridian between that point and the equator, which is the natural prime parallel (0° latitude). Longitude and latitude allow us to locate any place on the surface of the earth with precision (Figure 2.1).
FIGURE 2.1 Longitude and latitude of a point.
If we ignore the Earth's oblateness and consider Earth to be a perfect sphere, parallels can be assumed to be equidistantly spaced. For example, for every 1° of arc we would expect the same distance between parallels. The length of a 1° degree of latitude is roughly the same as that of a 1° degree of longitude at the equator (about 69 miles per degree). Note, however, that due to the Earth's oblateness, the surface curvature is less strong near the poles than at the equator. As a result, a 1° degree of latitude changes in length from the equator to the poles (the difference is about 0.7 miles). Thus, 1° degree of latitude at the poles is roughly 1% longer than at the equator. These small differences in the Earth's shape can affect atmospheric and ocean circulation patterns.
Let's now turn our attention to the relationship between the Earth and the Sun. The Earth is turning on its axis daily at the same time as it is circling the Sun. Furthermore, the Earth's rotation axis is tilted (obliquity) with respect to the plane of its orbit and wobbles over time (Figure 2.2). The angles at which the Sun's rays strike the Earth at different latitudes at different times of the day through the year are fundamental drivers of the ocean circulation and atmospheric temperatures, air pressure, winds, storms, and precipitation. These factors drive both weather and climate.
FIGURE 2.2 Earth's rotational axis.
Earth's spin on its polar axis is called Earth rotation. The period of Earth rotation is the mean solar day, a 24‐hour period that represents the average time required for the Earth to make a complete turn on its axis with respect to the Sun. The true direction of the Earth rotation is eastward, the opposite of the apparent westward motion of the Sun, Moon, and stars across the sky.
Although the Earth spins daily on
