An interesting argument has been made by Professor Riccardo Rebonato of the EDHEC-Risk Climate Institute in regards to future climate and socioeconomic scenarios such as the shared socioeconomic pathways (SSPs) and representative concentration pathways (RCPs) used by the Intergovernmental Panel on Climate Change in its assessment reports.

While the scenarios are informative and well researched, and have been used effectively to steer policy, Professor Rebonato argues that they are of limited value to risk managers and financial planners for two reasons. The first is that the connection between the socioeconomic and climate scenarios is quite rigid – “one assumption on economic growth results in a certain assumed level of population growth, or to a particular level of technological development, and so on”.

This means that the scenarios leave out the possibility of “climate black swans” (a reference to the term coined by Nassim Nicholas Taleb regarding highly improbable but highly consequential events, especially those that are not envisaged), engendering an “unwarranted sense of control”. The second is that such scenarios do not come with probabilities of occurring, meaning that the allocation of resources towards mitigating and adapting to them is most likely inefficient.

With finance always being limited, this is a deep problem. As an example, Professor Rebonato gives the IPCC’s RCP8.5, the most dire of the climate scenarios, which according to an article in Nature is “virtually impossible”, but is one of the most frequently cited scenarios in applied work. Assigning probabilities is very difficult, as the author acknowledges, but he suggests that there is work that can be done, such as using dynamic Bayesian nets, that combine degrees of ignorance with knowledge to come to relative probabilities.

This type of analytical tool would help financial planners and other economic managers, and would probably change prices of equities, which Professor Rebonato notes “barely seem to reflect either the major reallocation of investments required to seriously tackle climate change and the resulting losers and winners in different industrial sectors; or the aggregate impairment to economic output that failure to take climate action will entail.”

As this implies, use of such tools would also have a complex impact on industrial sectors, including those employing combustion.