An analytical framework to price long-dated climate-exposed assets
This paper uses a tractable stochastic integrated-assessment model to analyze the influence of climate change on asset returns across time and maturity. Analytical formulas allow to price various long-dated assets, including fixed-income products, derivatives, and equities. We find that climate risks will increasingly drive down long-term risk-free yields, reducing them by about 40 basis points by the end of the century, reflecting lower growth and increased uncertainty. We illustrate the concept of climate risk premiums–the excess returns asked by investors exposed to climate risks–by examining model-implied prices of long-term assets vulnerable to sea level rise or temperatures. Climate risk premiums are particularly sensitive to damage assumptions.