THE IMPACT OF CLIMATE CHANGE ON FINANCIAL MARKETS: A STUDY OF RISK ASSESSMENT AND PORTFOLIO MANAGEMENT STRATEGIES

Abstract

Climate change has become one of the greatest systemic risks in the international financial markets, dramatically changing the conventional risk analysis models as well as requiring new concepts of portfolio management. This paper reviews the complexity of the effects of climate risks on financial markets, focusing on both physical risks of extreme weather conditions, sea-level rise, and changes in temperature and transition risk arising due to policy shifts towards low-carbon economies, technological shocks and change in consumer preferences. This study shows how the climatic change has brought new volatility and correlation dynamics among asset classes by analyzing historical market information, climate forecaster and regulatory advancements comprehensively, revealing that the climate-induced volatility and correlation structures are not comparable with the previous experience due to excessive fluctuations and consequently unprecedented basics of correlations and diversifications. The publication states the dependence of financial institutions and investors on climate risks as material considerations in the value of their assets, their credit grades, and longer-term revenues and disperses the design of climate-vetted risk measures and stress testing procedures. Also, the study considers the new portfolio management practices, such as ESG integration, green finance tools, climate-resilient asset accommodation, and nature-based solutions investing, and assesses their success in terms of the reduction in climate-related financial risk. The results reveal that even the proactive climate risk management is not only a defensive business tool, but there are opportunities to create value, as climate winners and losers in the sector can be identified at an early stage. The work will add to the literature on climate finance by presenting empirical evidence of the practical effect of climate change on the financial markets and practical frameworks on the evaluation of risks and portfolios in the age of environment change acceleration.