Climate Models and Scenario Analysis
Models and scenarios
Climate models (general circulation models, Earth-system models) simulate physical climate; integrated assessment models (IAMs) link emissions, economics, and climate to produce socioeconomic pathways. The Shared Socioeconomic Pathways (SSPs) describe narratives (SSP1 sustainability to SSP5 fossil-fuelled) and pair with Representative Concentration Pathways (RCPs) for radiative forcing. SSP1-1.9 and SSP1-2.6 align with Paris goals; SSP5-8.5 is a high-emissions reference.
Scenario analysis for finance
Scenarios are not forecasts - they are plausible, internally consistent futures used to explore uncertainty. NGFS reference scenarios (orderly, disorderly, hot house world, too little too late) are widely used. Orderly transitions have early, smooth policy; disorderly transitions are delayed and abrupt, raising transition risk; hot house world implies high physical risk with limited transition.
Worked example
A bank tests a portfolio under NGFS Net Zero 2050 (orderly) and Divergent Net Zero (disorderly). The disorderly scenario shows sharper near-term asset repricing - higher transition risk - even though both reach net zero by 2050. Match scenario timing to risk type: late action raises transition risk.
Traps
- Treating a scenario as a prediction.
- Confusing RCP (concentration/forcing) with SSP (socioeconomic narrative).
- Assuming all net-zero scenarios have similar transition risk - timing matters.