Chapter 7: Climate Models and Scenario Analysis - PART 1

ayshasathar101
Sep 14, 2025
4 min read

What are Climate Models?

What is relation between Climate Models and Shared Socioeconomic Pathways?

In order to predict future climate change, we must first project how much greenhouse gas society will emit in the future. Because of the difficulty of making a single, confident projection of the future, a group known as the Integrated Assessment Modeling Consortium has developed a set of alternative pathways that they believe span the range of different futures the world may experience over the next century or two

These are referred to as Shared Socioeconomic Pathways, usually abbreviated SSPs. each representing a different way the world may evolve in the future.

The SSPs are labeled:

SSP1
SSP2
SSP3
SSP4
SSP5

It mainly differs in the amount of economic growth and the amount of climate-safe energy that is being deployed, which leads to different amounts of carbon dioxide emitted into the atmosphere each year.

From this, the amount of climate change under each scenario can be estimated by inputting atmospheric carbon dioxide into a computer simulation, known as a global climate model, sometimes referred to by its initials as a GCM.

What does Scenario Analysis mean?

When is Climate Scenario analysis used?

Climate scenario analysis is used to bolster corporate preparedness in the face of physical and transition-related climate impacts to communicate that preparedness to investors and other stakeholders and to guide strategy and investment decisions at all types of firms.

It is also starting to be integrated into asset allocation and investment decisions at some financial firms.

The TCFD (T ask Force on Climate-related Financial Disclosure) recommends scenario analysis as a way to "enhance critical strategic thinking" and challenge conventional wisdom regarding the future using plausible, distinctive, consistent, relevant, and challenging scenarios

Each organization and firm does face a different blend of climate-related risks and opportunities, and it can make sense to customize scenarios for firm-specific use, analysis of climate change s often done using a set of standard, cross-comparable scenarios .These reference scenarios are a set of agreed-upon projections of global emissions trajectories, with accompanying socioeconomic narratives and estimates for physical impacts

The most widely used, and widely agreed upon, reference scenarios are those created directly by the Intergovernmental Panel on Climate Change (IPCC), scenarios from the International Energy Agency, an international organization, and from various non-profit and academic sources are also widely used.

How do climate scenarios aid in risk management?

What is a deterministic scenario in climate risk analysis?

What role does forward-looking analysis play in climate risk management?

Example: 2 Degrees Investing Initiative, an NGO, has developed a methodology called the Paris Alignment Capital Transition Assessment (PACTA) tool, which has seen considerable uptake both among investors, with its equities and bonds version, and among banks, with the PACTA version on corporate loans, or PACTA for Banks.

PACTA for Banks starts with a bank's financial exposure to physical assets (such as steel or power plants) in the real economy. The methodology then compares economic units of output (e.g., tons of steel, MWh of electricity) to different climate change scenarios, allowing the bank to know which climate pathway its clients are on.

Which key metrices are used in climate stress testing?

MSCI (division of Morgan Stanley) a data provider, sells a commercial tool called "Climate Value at Risk," which, like standard VaR ( VaR is one of the best metrics of market risk and has therefore been adapted by at /east one data provider to look specifically at climate risk.), is meant to capture a rough estimate of climate-related financial losses.

The MSCI methodology is proprietary, the firm does disclose that it includes both transition and physical risks as well as economic data and company level data.
Climate risk, on both the transition and physical side, is calculated as a combination of hazards, vulnerability, and exposure that is converted into monetary amounts using a financial valuation model.
Aggregated at the sector level, CVaR shows that construction, coal, and electrical utilities are the most exposed sectors to a combination of physical and transition risks

How do stress tests reveal vulnerabilities in a Portfolio?

What are Stress tests?

Stress tests are another micro- and macroprudential tool at the disposal of central banks. Such tests model the reaction of an individual financial institution or the whole financial system to a hypothetical shock were already widely adopted by regulators in the wake of the Global financial crisis of 2008, and they are now being adapted to examine the potential impact of climate change.

How do regulators view climate stress testing?

Stress tests were widely adopted by regulators in the wake of the global financial crisis of 2008 and are now increasingly being repurposed to examine climate change risk.

NOTE: The Bank of England (BoE), the Banque de France, and the Nederlandsche Bank (the Dutch central bank), as well as the European Central Bank are at various stages of implementing climate stress tests with differing degrees of granularity, distinct climate and policy scenarios, time horizons, and feedback loops.