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A holistic view on climate risk and practical ways to model and measure it Advanced Analytical Methods for Climate Risk and ESG Risk Management provides risk management professionals and other interested parties with an introduction to climate risk, a detailed history of climate change, and analytical risk management methods. Readers will gain insight on the potential impact of climate change and learn to apply a concrete three-pronged framework for risk modelling and assessment. The management of climate risk-regardless of the size of the business or of the potential loss-is also…mehr
A holistic view on climate risk and practical ways to model and measure it
Advanced Analytical Methods for Climate Risk and ESG Risk Management provides risk management professionals and other interested parties with an introduction to climate risk, a detailed history of climate change, and analytical risk management methods. Readers will gain insight on the potential impact of climate change and learn to apply a concrete three-pronged framework for risk modelling and assessment. The management of climate risk-regardless of the size of the business or of the potential loss-is also considered in detail, with discussions of risk allocation, portfolio optimization, regulatory constraints, and sustainable goal setting.
The development of advanced risk management analytical methods for ESG and climate risk is limited. This book fills a gap by offering a comprehensive review of modelling theory and methods for addressing the accelerating changes to the planet's climate.
Gain thorough background knowledge of climate science, the history of climate change, and the current political and public policy landscape
Understand how global climate shifts introduce localized impacts to business
Identify, measure, and manage financial and operational risks
Utilize a concrete methodology for stress testing portfolios and accounting for risk
Risk management professionals in financial institutions, along with academics and advanced students of economics and finance, will be grateful for this comprehensive approach to climate and ESG risk. Regulators will also benefit from the thorough considerations outlined in Advanced Analytical Methods for Climate Risk and ESG Risk Management.
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Autorenporträt
JORGE SOBEHART has over 35 years of experience in advanced quantitative modelling in industry and government, having worked for prestigious institutions including the Atomic Energy Commission of Argentina (Nuclear Fusion Division), the Center for Nonlinear Studies at the US Los Alamos National Laboratory, Moody's Investors Service, and CASA, a cutting-edge financial consulting start-up, making contributions in the fields of risk management, behavioral finance, theoretical and applied physics, computation and mathematical modeling. He also acted as a technical reviewer for several book editors and over a dozen professional journals in these fields. He is currently a Managing Director at a large global financial institution, leading analytics for wholesale credit and climate risk and risk ratings. During his career, he designed and developed frameworks for wholesale credit risk capital and allocation, credit and climate risk stress testing (CCAR, ICAAP, Climate Risk), credit reserves (CECL, IFRS9, FAS5), risk ratings, probability of default and various early warning tools of credit deterioration.
Inhaltsangabe
Introduction: Climate Risk and Environmental, Social and Governance Challenges xiii Chapter 1 Introduction to Climate Risk 1 Dimensions of Climate Risk 1 Basic Concepts of Climate 2 Carbon Dioxide, Greenhouse Gases (GHG), and Air Pollution 5 The Science of Climate Change 6 Climate Change, the Intergovernmental Panel on Climate Change (IPCC) Reports, and Social Change 10 References 12 Chapter 2 Forces of Nature 15 The Astronomical Theory of Climate Change 15 The Sun 24 The Earth 27 Air and Wind 30 Water and Ice 32 The Carbon Cycle 34 Note 36 References 36 Chapter 3 A Brief History of Climate Change 39 Natural Drivers of Climate Change Over the Ages 39 Frozen Earth 40 Warming and Freezing Cycles and Periodic Glaciations 41 The Last Ice Age, Younger Dryas, and Climate Cycles 42 Climate Change in Ancient Times 43 Roman Warm Period 44 The Climate in the Dark Ages 44 The Medieval Warm Period 45 The Little Ice Age 46 The Industrial Revolution and Man-Made Effects 48 Today and Tomorrow 52 References 52 Chapter 4 Science, Politics, and Public Policy 55 Science, Facts, Perception, Social Influence, Misinformation, and Fear 55 Behavioral Aspects of Risk Taking and Decision Making 56 Perception and Plausibility of Events 59 Trust, Deception, Credibility, and Fake News 60 Social Pressure, Conformity, and Media Bias 63 Social Polarization 65 Opinion Polarization under Social Pressure and Media Bias 67 Social Pressure, Media Bias, and Perception for Different Groups 70 Choice Impact for Different Groups 74 What's Next? Tackling the Climate Change Challenge 76 References 78 Chapter 5 Global Shift in Response to Climate Change 81 The Shift in the Global Economy in Response to Climate Change 81 Technology Change: First Movers, Competitive Landscape, and Economic Environments 87 Climate Risk Uncertainty in Competitive Business Environments 90 Innovation and Product Dynamics 93 Product Adoption 95 Product Competition 98 Multiple Competitor Environments 100 Uncertainty in Competitive Environments 103 Notes 107 References 107 Chapter 6 Risk Management for Climate Risk and ESG 111 Overview, Purpose, Scope of Risk Management, and Governance 111 Risk Identification, Measurement, and Management 113 Regulatory Environment and Climate Risk 126 Operational Readiness and Resilience for Climate-Related Effects 128 Risk Monitoring and Reporting 132 Risk Reporting and Analysis 133 Reshaping the Industry Landscape: Winners, Losers, and Synergies 135 Sustainability, Competitive Environment, and a Level Playing Field 138 Climate-Related Financial Disclosures 138 Climate Risk Financial Disclosures 143 Building a Stress-Testing Framework for Climate Risk Using ThreeCorePillars 155 References 161 Chapter 7 Pillar 1: Competitive Landscape and Climate Risk Scenarios for Stress Testing 163 Assessing the Industry and Regulatory Landscape, Synergies, and Complexities of Competitive Business Environments 163 Scenarios for the Global Economy: Economic, Business, and Credit Cycles 164 Business Cycles, Credit Supply, and Demand 171 Economic Drivers 173 Economic Activity and Credit Demand 174 The Impact of Local Economic Conditions on Global Obligors 206 References 208 Chapter 8 Pillar 2: Demand for Credit: Modeling Default Risk and Loss Severity 211 Supply and Demand for Credit: Excess Credit Demand 211 Analysis of Economic Activity 216 Defining Key Concepts: Default, Loss Likelihood, and Loss Severity 217 Credit Correlation 232 Note 239 References 239 Chapter 9 Pillar 2: Demand for Credit: Risk Assessment and Credit Risk Ratings 245 The Path to Business Failure 245 Risk Assessment and Credit Risk Ratings 246 Credit Risk Ratings 248 Default and Loss Concepts and Risk Ratings 259 Default Rate Statistics by Rating Category 261 Rating Transition Matrices 264 Rating Transitions and the Term Structure of Default Rates 265 Portfolio Risk Rating 267 Portfolio Trend Rating 267 Risk Management Rating 267 Rating Stability 270 Quantifying Analysts' Perception of Credit Risk: A Behavioral Model 271 Notes 295 References 295 Chapter 10 Pillar 2: Demand for Credit: The Value of Financial Information 297 The Value of Financial Information: Balance Sheet, Income Statement, and Statement of Cash Flows 297 The Balance Sheet 298 The Income Statement 305 The Statement of Cash Flows 309 Financial Information and Uncertainty 313 Cash Liquidity and Debt Capacity 314 Cash Shortfall, Business Uncertainty, and Financial Distress 317 Note 321 References 321 Chapter 11 Pillar 2: Demand for Credit: Models of Business Failure 325 Credit Risk Models of Business Failure 325 Model Selection 329 Statistical and Econometric Models 330 Credit Scoring and Statistical Discriminant Analysis 333 Models of Probability of Default 340 Nonlinear Models 343 Statistical Inference and Bayesian Methods 345 Model Selection Criteria: Least Squares and Likelihood Methods 347 Information Entropy Methods and Model Selection 348 A Primer on Neural Networks 356 Validating Statistical Models 361 Measuring Model Accuracy 361 A Validation Approach for Quantitative Models 363 Resampling 368 Model Performance and Benchmarking 368 References 380 Chapter 12 Pillar 2: Structural Models 383 The Role of Market Information in the Pricing of Risky Debt 383 Options Pricing, Randomness, and the Notion of Limit 386 Options Pricing and Stochastic Calculus 386 Ito Stochastic Integrals, Convergence, and the Notion of Limit 389 Hedging Portfolio Returns in the Limit vs. Hedging the Limit of Portfolio Changes 391 Residual Risk and Volatility Skews 394 Hedging Strategies and Residual Risk 395 Models and Assumptions 397 Asset-Based Models and Market Uncertainty 398 Forward-Looking, Singular Perturbation Analysis 400 Market Uncertainty and the Valuation of Equity and Debt 408 Revisiting the Default Point 412 The Role of the Company's Borrowing Capacity 413 Joint Distribution of Assets, Equity, and Debt 415 Uncertainty, Arbitrage, and Equity-Debt Relationship 421 Notes 424 References 424 Chapter 13 Pillar 3: Supply of Credit: Modeling Lender's Behavior and Business Strategies 429 Portfolio Management 429 Estimating Portfolio Losses 434 References 448 Acknowledgments 451 About the Author 453 Index 455
Introduction: Climate Risk and Environmental, Social and Governance Challenges xiii Chapter 1 Introduction to Climate Risk 1 Dimensions of Climate Risk 1 Basic Concepts of Climate 2 Carbon Dioxide, Greenhouse Gases (GHG), and Air Pollution 5 The Science of Climate Change 6 Climate Change, the Intergovernmental Panel on Climate Change (IPCC) Reports, and Social Change 10 References 12 Chapter 2 Forces of Nature 15 The Astronomical Theory of Climate Change 15 The Sun 24 The Earth 27 Air and Wind 30 Water and Ice 32 The Carbon Cycle 34 Note 36 References 36 Chapter 3 A Brief History of Climate Change 39 Natural Drivers of Climate Change Over the Ages 39 Frozen Earth 40 Warming and Freezing Cycles and Periodic Glaciations 41 The Last Ice Age, Younger Dryas, and Climate Cycles 42 Climate Change in Ancient Times 43 Roman Warm Period 44 The Climate in the Dark Ages 44 The Medieval Warm Period 45 The Little Ice Age 46 The Industrial Revolution and Man-Made Effects 48 Today and Tomorrow 52 References 52 Chapter 4 Science, Politics, and Public Policy 55 Science, Facts, Perception, Social Influence, Misinformation, and Fear 55 Behavioral Aspects of Risk Taking and Decision Making 56 Perception and Plausibility of Events 59 Trust, Deception, Credibility, and Fake News 60 Social Pressure, Conformity, and Media Bias 63 Social Polarization 65 Opinion Polarization under Social Pressure and Media Bias 67 Social Pressure, Media Bias, and Perception for Different Groups 70 Choice Impact for Different Groups 74 What's Next? Tackling the Climate Change Challenge 76 References 78 Chapter 5 Global Shift in Response to Climate Change 81 The Shift in the Global Economy in Response to Climate Change 81 Technology Change: First Movers, Competitive Landscape, and Economic Environments 87 Climate Risk Uncertainty in Competitive Business Environments 90 Innovation and Product Dynamics 93 Product Adoption 95 Product Competition 98 Multiple Competitor Environments 100 Uncertainty in Competitive Environments 103 Notes 107 References 107 Chapter 6 Risk Management for Climate Risk and ESG 111 Overview, Purpose, Scope of Risk Management, and Governance 111 Risk Identification, Measurement, and Management 113 Regulatory Environment and Climate Risk 126 Operational Readiness and Resilience for Climate-Related Effects 128 Risk Monitoring and Reporting 132 Risk Reporting and Analysis 133 Reshaping the Industry Landscape: Winners, Losers, and Synergies 135 Sustainability, Competitive Environment, and a Level Playing Field 138 Climate-Related Financial Disclosures 138 Climate Risk Financial Disclosures 143 Building a Stress-Testing Framework for Climate Risk Using ThreeCorePillars 155 References 161 Chapter 7 Pillar 1: Competitive Landscape and Climate Risk Scenarios for Stress Testing 163 Assessing the Industry and Regulatory Landscape, Synergies, and Complexities of Competitive Business Environments 163 Scenarios for the Global Economy: Economic, Business, and Credit Cycles 164 Business Cycles, Credit Supply, and Demand 171 Economic Drivers 173 Economic Activity and Credit Demand 174 The Impact of Local Economic Conditions on Global Obligors 206 References 208 Chapter 8 Pillar 2: Demand for Credit: Modeling Default Risk and Loss Severity 211 Supply and Demand for Credit: Excess Credit Demand 211 Analysis of Economic Activity 216 Defining Key Concepts: Default, Loss Likelihood, and Loss Severity 217 Credit Correlation 232 Note 239 References 239 Chapter 9 Pillar 2: Demand for Credit: Risk Assessment and Credit Risk Ratings 245 The Path to Business Failure 245 Risk Assessment and Credit Risk Ratings 246 Credit Risk Ratings 248 Default and Loss Concepts and Risk Ratings 259 Default Rate Statistics by Rating Category 261 Rating Transition Matrices 264 Rating Transitions and the Term Structure of Default Rates 265 Portfolio Risk Rating 267 Portfolio Trend Rating 267 Risk Management Rating 267 Rating Stability 270 Quantifying Analysts' Perception of Credit Risk: A Behavioral Model 271 Notes 295 References 295 Chapter 10 Pillar 2: Demand for Credit: The Value of Financial Information 297 The Value of Financial Information: Balance Sheet, Income Statement, and Statement of Cash Flows 297 The Balance Sheet 298 The Income Statement 305 The Statement of Cash Flows 309 Financial Information and Uncertainty 313 Cash Liquidity and Debt Capacity 314 Cash Shortfall, Business Uncertainty, and Financial Distress 317 Note 321 References 321 Chapter 11 Pillar 2: Demand for Credit: Models of Business Failure 325 Credit Risk Models of Business Failure 325 Model Selection 329 Statistical and Econometric Models 330 Credit Scoring and Statistical Discriminant Analysis 333 Models of Probability of Default 340 Nonlinear Models 343 Statistical Inference and Bayesian Methods 345 Model Selection Criteria: Least Squares and Likelihood Methods 347 Information Entropy Methods and Model Selection 348 A Primer on Neural Networks 356 Validating Statistical Models 361 Measuring Model Accuracy 361 A Validation Approach for Quantitative Models 363 Resampling 368 Model Performance and Benchmarking 368 References 380 Chapter 12 Pillar 2: Structural Models 383 The Role of Market Information in the Pricing of Risky Debt 383 Options Pricing, Randomness, and the Notion of Limit 386 Options Pricing and Stochastic Calculus 386 Ito Stochastic Integrals, Convergence, and the Notion of Limit 389 Hedging Portfolio Returns in the Limit vs. Hedging the Limit of Portfolio Changes 391 Residual Risk and Volatility Skews 394 Hedging Strategies and Residual Risk 395 Models and Assumptions 397 Asset-Based Models and Market Uncertainty 398 Forward-Looking, Singular Perturbation Analysis 400 Market Uncertainty and the Valuation of Equity and Debt 408 Revisiting the Default Point 412 The Role of the Company's Borrowing Capacity 413 Joint Distribution of Assets, Equity, and Debt 415 Uncertainty, Arbitrage, and Equity-Debt Relationship 421 Notes 424 References 424 Chapter 13 Pillar 3: Supply of Credit: Modeling Lender's Behavior and Business Strategies 429 Portfolio Management 429 Estimating Portfolio Losses 434 References 448 Acknowledgments 451 About the Author 453 Index 455
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