Climate overlay

The climate overlay layers a TCFD / NGFS-style stress scenario onto any underlying structural model — Merton, Black-Cox, CreditGrades, Leland-Toft, or a user-defined extension. The construction is intentionally simple so that practitioners can substitute their house view of carbon prices and sectoral PD multipliers without rewriting the underlying calibration.

The overlay is a specialisation of the package’s general scenarios framework. Where the atomic shocks (equity_shock, vol_shock, rate_shock, debt_shock) mutate a single :class:~merton.core.firm.Firm field, a

class:

~merton.scenarios.climate.ClimateScenario derives the equity writedown from a carbon-price path and sectoral emission intensities, then layers a sectoral PD multiplier on top of the structural fit.

Construction

A :class:~merton.scenarios.climate.ClimateScenario consists of three pieces:

  1. Carbon-price path \(c(t)\), a callable from horizon (years) to a USD-per-tonne-CO₂e price. The packaged scenarios use piecewise-linear curves; the helper :func:merton.scenarios.climate.carbon_price_curve builds one from a list of (t, price) knots.

  2. Sectoral PD multipliers \(\{m_s\}\) — a mapping from

    class:

    ~merton.scenarios.climate.Sector to a multiplier. Multipliers above 1 reflect residual default-risk premia not captured by an equity-side asset writedown (regulatory transition risk, demand destruction, technology obsolescence). Sectors absent from the mapping default to 1.0.

  3. Pass-through and physical-risk parameters — pass_through ∈ [0, 1] is the fraction of the carbon cost passed through to customers (higher pass-through ⇒ smaller equity hit), and physical_writedown is an annual fractional writedown capturing chronic physical risk.

Asset writedown

For a sector with emission intensity \(I_s\) (tCO₂e per \(M EV) at horizon \)T$, the transition writedown is

\[ w_T = \min\!\left(1,\, (1 - \text{pass\_through})\,\frac{c(T)\,I_s}{10^6}\right). \]

Combined with a horizon-scaled chronic physical writedown \(w_P\) the total writedown is

\[ w = \min\!\bigl(1,\, w_T + (1 - w_T)\,w_P\bigr), \]

i.e. the physical writedown attacks whatever’s left after the transition hit. The package then sets the stressed equity to \(E \cdot (1 - w)\) before running the base structural calibration.

PD scaling

After the base model fits the stressed firm and returns \(\text{PD}_\text{base}\), the overlay applies the sectoral multiplier:

\[ \text{PD}_\text{climate} = \min\!\bigl(1,\, m_s \cdot \text{PD}_\text{base}\bigr). \]

This two-step decomposition keeps the writedown and multiplier-driven adjustments separately reportable: dashboards can show which of the two components dominates the stress for each firm.

NGFS Phase V scenarios

The :mod:merton.scenarios.predefined.ngfs module bundles four practitioner-facing scenarios aligned with the NGFS Phase V 2024 release:

Scenario

Carbon @ 2035

Carbon @ 2050

Physical risk

:func:~merton.scenarios.predefined.ngfs.net_zero_2050

~$300/tCO₂e

~$700/tCO₂e

Low

:func:~merton.scenarios.predefined.ngfs.delayed_transition

~$400/tCO₂e (post-2030 spike)

~$650/tCO₂e

Moderate

:func:~merton.scenarios.predefined.ngfs.current_policies

~$50/tCO₂e

~$70/tCO₂e

High (chronic)

:func:~merton.scenarios.predefined.ngfs.fragmented_world

~$120/tCO₂e

~$260/tCO₂e

Moderate

Defaults reflect the most-cited variants of each scenario in publicly available NGFS documentation and IIGCC / MSCI Climate Lab Insights commentary. They are intended as starting points for portfolio stress analysis; replace with your firm’s house view where appropriate.

References

  • NGFS (2024). NGFS Phase V Climate Scenarios for Central Banks and Supervisors. November 2024.

  • IEA (2024). World Energy Outlook 2024. International Energy Agency.

  • TCFD (2017). Recommendations of the Task Force on Climate-Related Financial Disclosures.