Temperature shocks and the cost of equity capital: implications for climate change perceptions

Abstract

Financial market information can provide an objective assessment of losses anticipated from climate change. In a Merton-type asset pricing model, with asset prices affected by perceived changes in investment opportunities due to climate change, the risk premium is significantly negative, loadings for most assets are negative, and asset portfolios in more vulnerable industries have stronger negative loadings on a temperature shock factor. Weighted average increases in the cost of equity capital attributed to climate change are 0.22 percent, implying a present value loss of 7.92 percent of wealth. These costs complement previous estimates of the cost of climate change. Valuation Insight: Balvers, Du, and Zhao consider how climate change affects market values in different industries and should be a factor in valuation. They show that costs of equity capital increase in the industries most vulnerable to climate change resulting from uncertainty about the extent of climate change. They estimate for the U.S. a present value cost of around eight percent of wealth due to climate change.