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new research paper
physical risk pricing framework

Gain the ability to price physical risk

Physical risk is already reflected in some financial inputs, but its transmission remains partial and uneven. TLG’s framework traces risk from hazard, physical exposure and physical vulnerability, through dependency and operational flexibility, into the cash flows and required returns of a specific financial claim. It helps investors recognise material exposure that conventional valuation inputs may not yet represent fully.

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the market failure

Physical risk is only partially reflected in financial prices

Unevenly reflected in the inputs

Hazard and asset location increasingly appear in risk assessments and some capital-market estimates. Ecological condition, physical vulnerability, dependency and operational flexibility remain less consistently measured or transmitted into valuation.

Ecological condition can change hazard or vulnerability

Ecological and engineered conditions can change hazard or physical vulnerability, depending on the causal mechanism. The same physical stress can therefore produce different outcomes across assessment units.

Disclosure without price

TNFD and CSRD improve disclosure, but disclosure does not itself establish a financial price. Until the relevant physical and economic information is represented in cash flows, market parameters or claim-specific risk inputs, material exposure can remain incompletely transmitted.
for equity

Physical Risk Adjustment (PRA): a holder-specific treatment of residual physical risk

The PRA is an additive adjustment to the cost of equity used principally in holder-specific valuation. It applies only to material physical risk that remains outside expected cash flows and the baseline required return, is demonstrably borne by the relevant holder, and has not already been compensated through beta, total beta or another adjustment. Its current calibration is a judgemental shadow price—not an empirically estimated market premium.

Re = Rf + β(Rm − Rf) + PRA
An additive adjustment within CAPM for an eligible holder-specific residual—not a universal market premium.
Fig 01 / Physical Risk Adjustment in CAPM

PRA = judgemental shadow-pricing adjustment for an eligible holder-specific residual.

PRP = potential market compensation for systematic physical risk borne by diversified investors.

The current evidence does not yet support calibration of a standalone PRP.

for debt

For credit: translate the same upstream risk through the debt claim

The upstream physical and economic assessment is common across financial applications. Credit analysis then translates that risk through earnings capacity, liquidity, debt-service capacity, collateral value and recovery prospects. Where the evidence supports the relationship, these consequences can inform PD, LGD, spreads, covenants and tenor.

Expected Loss = PD × LGD × EAD
Physical and economic deterioration can affect PD and, where collateral value depends on the affected physical system, LGD.
Fig 02 / Claim-specific credit translation
Sector calibration

Sector-informed, refined to the activity

Sector-level dependency evidence can provide a practical prior where company-specific information is unavailable. Firm-, asset- and activity-specific evidence should replace that prior where possible, particularly evidence on dependency, operational flexibility and the physical mechanism being assessed.

use cases

Where it applies

Equity valuation / DCF

Allocate sufficiently estimable consequences to expected cash flows first. Apply a PRA only to the remaining holder-specific residual after checking diversification, the baseline required return and potential double counting.

Portfolio screening

Screen holdings for shared hazards, physical dependencies and correlated exposures across the portfolio. Screening identifies where deeper valuation analysis is required; it does not by itself determine a discount-rate adjustment.

ESG / sustainability integration

Connect ecological condition and physical risk to financial analysis through a documented physical–economic–financial transmission chain.

Credit assessment

Assess how physical and economic consequences affect earnings, liquidity, debt-service capacity, collateral and recovery before adjusting PD or LGD.

Credit rating calibration

Use claim-specific evidence to inform rating analysis where the relationship between physical risk and creditworthiness can be demonstrated.

Loan structuring

Inform collateral, covenant and tenor decisions where physical and economic risk is material to asset performance or repayment capacity.
what you get

Built for you in Landler

The framework runs in Landler as a custom build, scoped around your assessment units, hazards, activities, portfolio, financial claims and valuation purpose.

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