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Pricing natural-disasters and climate-change risks: Insights from CAPM with self and externally excited jumps

Author

Listed:
  • Radi, D.
  • Santacroce, M.
  • Trivellato, B.

Abstract

We study the effect of climate change on market’s risk premium and stock volatility through a general equilibrium asset pricing model with recursive preferences. We consider a financial market affected by environmental and macroeconomic shocks, both featuring time-varying intensities. Additionally, we incorporate the effects of green policies specifically targeting carbon-intensive assets. To capture the increasing frequency and clustering behavior of environmental risks, the model includes self-exciting and externally excited jump intensities for natural rare disasters. The representative agent’s consumption–investment maximization problem is solved in closed form, and the analytical results suggest that consumption disasters with time-varying probability reduce the risk-free interest rates while increasing the market’s premium and volatility of the stock market. The asymmetric impact of the transition risk on assets affects the optimal portfolio composition. Neglecting the clustering-like nature of environmental shocks lead to underestimate these effects.

Suggested Citation

  • Radi, D. & Santacroce, M. & Trivellato, B., 2026. "Pricing natural-disasters and climate-change risks: Insights from CAPM with self and externally excited jumps," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 249(C), pages 583-610.
    • Handle: RePEc:eee:matcom:v:249:y:2026:i:c:p:583-610
    DOI: 10.1016/j.matcom.2026.05.016
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    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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