Navigating Climate Risk in Financial Markets: New Theories and Insights for Asset Pricing

Climate change has a significant impact on the global economy and financial markets, making climate risk and uncertainty central to asset pricing decisions. These risks include potential economic losses due to extreme weather events or gradual changes and can impact business redundancy, infrastructure stability, and approval channels. We review the main theoretical models that incorporate climate risk in asset pricing and the empirical methods to assess the existence of a climate risk premium. Building on this literature, we develop three original theorems that advance our understanding of climate risk pricing dynamics, provide a framework for climate-adjusted discount rates, and establish the relationship between climate risk diversification and portfolio optimization under uncertainty.