Degrees of Uncertainty – Quantifying Uncertainties of Temperature Alignment Metrics for Climate Risk Management

Climate risk is increasingly understood as a major threat to the stability of the financial system. As public awareness and regulatory scrutiny rise, financial institutions face multifaceted pressure to progress on the task of managing climate risks. One of the biggest challenges in determining the best methodologies and models to measure climate risk is the quantification of uncertainties. This is a crucial step toward one day reliably assessing the scope and impact of these risks – and pricing them accordingly.

In this whitepaper, we take a first step towards quantifying the uncertainties in our own X-Degree Compatibility (XDC) Model, which calculates the ‘temperature alignment’ of portfolios as well as single securities from various asset classes. To convert emissions to temperature, the XDC Model draws on the Finite Amplitude Impulse Response (FaIR) climate model. Our research explores a parametric uncertainty quantification for the FaIR Model and its implications for climate risk management.