How can climate risk stress testing be implemented?

Abstract

This paper is a practical introduction to the nascent methodology of climate risk stress testing. After giving a general overview of the physical climate models that underlie climate risk projections, it discusses how a financial institution can leverage open-source physical risk data and climate models employed by the scientific and policy communities to perform both physical and transition risk stress tests. The paper develops two examples of physical risk stress testing: 1) a stress test of the effect of temperature increases on labour productivity; and 2) a stress test of the physical damage of hurricanes. The paper goes on to explain what transition risk is and then explores how models already in use by the climate policy community can serve as a foundation for transition risk stress testing.