N°23-26: Bounding the Impact of Hazard Interdependence on Climate Risk

The severity of extreme weather events is increasing due to climate change, giving rise to physical climate risk. However, physical climate risk is not only driven by the severity of individual hazards, but also by the interdependence of those hazards. This paper establishes bounds for the impact of interdependence on the Expected Shortfall for a portfolio of damages from 13 weather hazards, namely Avalanche, Cold, Dust Storm, Flood, Fog, Hail, Heavy Rain, High Winds, Hurricane, Ice/Snow, Landslide, Tornado, and Wildfire. We empirically estimate the tail risk of multi-hazard portfolios for the limiting cases of independence and perfect dependence, relying on data from NOAA’s Storm Events Database from 1996 to 2021. We apply the extreme value theory approach of Cirillo and Taleb (2016) to calculate the Expected Shortfall. We find that assuming perfect dependence instead of independence increases the Expected Shortfall by 3.6% to 66.5% for a portfolio with equally weighted exposure to all 13 hazards, and by a factor of 1.44 to 7.06 for a risk-weighted portfolio.