Integrated Assessment Models (IAMs): Bridging Climate Science and Investment Strategy


How complex climate-economic models are shaping financial risk tools and informing sustainable allocation decisions

In a world increasingly defined by climate-related uncertainty, financial institutions are turning to an unlikely toolkit: models originally designed by climate scientists. Integrated Assessment Models (IAMs), once the purview of economists and environmental researchers, are now playing a central role in stress testing portfolios, informing transition scenarios, and shaping capital flows in sustainable finance.



But what are IAMs, how do they work, and why are they suddenly relevant to institutional investors? What Are Integrated Assessment Models? IAMs are computational frameworks that integrate knowledge from multiple disciplines—including climate science, economics, energy systems, land use, and policy—to simulate how different climate and policy scenarios unfold over time.



The most well-known IAMs include:




  1. DICE (Dynamic Integrated Climate-Economy model) – Developed by William Nordhaus, integrates climate and economic feedbacks.
  2. REMIND (Regional Model of Investments and Development) – Used for long-term global energy scenarios.
  3. IMAGE – Combines energy, land-use, and climate systems with socio-economic dynamics.

Each model varies in complexity, geography, assumptions, and sectoral coverage—but all aim to answer the core question: What does a particular emissions or policy pathway mean for the economy, the environment, and society? IAMs and Finance: Why It Matters Now For years, IAMs were confined to academic and policy spaces, informing Intergovernmental Panel on Climate Change (IPCC) scenarios like SSPs (Shared Socioeconomic Pathways) and RCPs (Representative Concentration Pathways).



Today, they form the backbone of tools used by:




  1. Central banks (e.g. NGFS climate scenarios)
  2. Regulators (e.g. ECB, BoE stress testing)
  3. Asset managers (e.g. portfolio alignment tools)
  4. Multilateral institutions (e.g. IEA Net-Zero Roadmap)

IAMs offer a structured way to link macroeconomic trajectories, policy ambition, and technological change to physical climate outcomes—making them indispensable for scenario analysis, climate risk disclosures, and transition planning.



Key Concepts Financial Professionals Should Understand




1. Carbon Pricing and Discounting

IAMs use shadow carbon prices to simulate policy impacts on emissions. The choice of discount rate dramatically affects outcomes, especially in long-term asset pricing.




2. Mitigation Pathways

IAMs can model how different sectors must decarbonize under various temperature goals (e.g. 1.5°C vs. 2°C), influencing expectations around sectoral transition risk.




3. Physical vs. Transition Risk

While IAMs traditionally emphasize transition pathways, their newer iterations integrate feedbacks from climate damages—helping model asset exposure to chronic risks like drought, flooding, or heat.




4. Cost-Benefit vs. Cost-Effectiveness Models

Some IAMs aim to find the “optimal” policy pathway based on trade-offs; others simply evaluate how to meet a given target (e.g. net zero) at lowest cost.



Limits and Caveats Despite their utility, IAMs come with limitations:




  1. Simplifying assumptions: Real-world complexities—like geopolitical disruption or behavior change—may be poorly captured.
  2. Omission of tipping points: Many models exclude non-linear climate feedbacks like permafrost thaw or ice sheet collapse.
  3. Ethical choices: Discount rates and damage functions embed normative judgments about intergenerational equity.

As a result, IAM outputs should be viewed as decision-support tools, not forecasts.



Implications for Financial Institutions Understanding IAMs allows investors to:




  1. Interpret transition risk scenarios (e.g. NGFS “Delayed Transition” or “Orderly”)
  2. Align portfolios with climate benchmarks (e.g. IEA Net Zero 2050)
  3. Stress-test sectors and geographies
  4. Anticipate regulatory shifts as policymakers respond to model insights

Leading institutions are embedding IAM-derived scenarios into climate Value-at-Risk (VaR) frameworks and green taxonomies, making familiarity with these models a competitive edge.



The Future of IAMs: Toward Granularity and Transparency IAMs are evolving toward greater regional detail, real-world constraints, and open-source platforms. Projects like the Open Integrated Assessment Model (OpenIAM) aim to make modelling tools more accessible to non-academic users, including climate data providers, insurers, and asset allocators.



As markets demand more forward-looking, science-aligned investment frameworks, IAMs are set to become a cornerstone of sustainable finance analytics.



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