Climate Scenarios

What Are Climate Scenarios?

Climate scenarios in finance are hypothetical models used to predict the impact of climate change on economic and financial systems. They help in assessing and managing climate-related risks and opportunities by providing insights into potential future environmental conditions and their socioeconomic implications. These climate scenarios guide financial institutions in stress testing, strategic planning, and understanding how different climate outcomes could affect investments, asset values, and financial stability over the long term. Climate scenarios are commonly generated from integrated assessment models (IAMs).

The MathWorks Modelscape solution can help financial services easily use climate scenario data in their modeling and risk processes—or even run modern encapsulated IAMs to generate new scenario data.

Model showing inputs such as GDP through IAMs to climate scenario, economy, and energy outputs.

An IAM links economic inputs to climate scenarios and energy outputs.

Understanding Climate Scenario Analysis in Financial Modeling

Climate scenario analysis in financial modeling is a pivotal process that integrates hypothetical climate models to assess potential impacts on financial systems. These scenarios, derived from tools like IAMs, provide insights into how environmental changes could influence economic and financial stability. Key frameworks such as NGFS Scenarios, IPCC RCPs, IEA Scenarios, and MIT’s EPPA model offer diverse perspectives, aiding financial institutions in stress testing and strategic planning. This analysis helps in understanding the financial implications of various climate outcomes, ensuring preparedness for climate-related risks and opportunities in the financial sector.

Popular climate scenario frameworks used in financial modeling are:

  • NGFS Scenarios: Developed by the Network for Greening the Financial System, these scenarios focus on the financial risks of climate change. They provide a range of pathways that consider different levels of global warming and policy actions, helping financial institutions understand and manage climate-related risks. Utilizing the NGFS scenarios in the MathWorks Modelscape solution, financial analysts can simulate and visualize the financial risks associated with different global warming levels.
  • IPCC RCPs (Representative Concentration Pathways): These are scenarios developed by the Intergovernmental Panel on Climate Change. They depict four different climate futures based on varying levels of greenhouse gas emissions, used to project changes in climate variables such as temperature and sea levels. The UN’s SSPs (Shared Socioeconomic Pathways) complement the RCPs by focusing on socioeconomic developments.
  • IEA Scenarios: The International Energy Agency’s scenarios, prominent in their World Energy Outlook reports, primarily focus on the energy sector. They explore various energy futures based on different policy and technology assumptions, highlighting the impact on energy demand, supply, and greenhouse gas emissions.
  • MIT EPPA (Emissions Prediction and Policy Analysis) Scenarios: Developed by the Massachusetts Institute of Technology, the Economic Projection and Policy Analysis (EPPA) model is part of the MIT Integrated Global Systems Model (IGSM) that represents the human systems. EPPA is a recursive-dynamic multiregional general equilibrium model of the world economy, which is built on the Global Trade Analysis Project (GTAP) data set and additional data for the greenhouse gas and urban gas emissions. IGSM is designed to develop projections of economic growth and anthropogenic emissions of greenhouse-related gases and aerosols. MathWorks, working with MIT, has made the EPPA scenario easily accessible in Modelscape.
A screenshot showing climate scenarios used to calculate bank losses displayed as histograms.

Climate stress test results based on probabilistic extension of the EPPA scenarios showing the divergence in outcomes for two difference banks based on their climate risk exposure.

MathWorks provides powerful tools for working with climate scenario data and integrating it into your financial modeling and risk management processes.

See also: climate stress testing, quantitative finance and risk management, climate research, Mapping Toolbox