This article provides a comprehensive survey of the current state and future challenges of climate finance research. This article is a paper by Kazuhiro Hiraki published in Financial Research Vol. 44 No. 3 (July 2025), systematically organizing and analyzing literature in the rapidly developing climate finance field from the perspective of three basic functions of financial markets.
Regarding the first perspective of "price discovery and risk transfer functions," it is pointed out that while climate-related risks are gradually being incorporated into asset prices, mispricing may still remain. Both physical risks (direct physical damage from climate change) and transition risks (risks associated with transition to a low-carbon economy) show gaps between market participants' awareness and actual risks. Meanwhile, research on hedging climate-related risks has advanced, with development of new risk management methods progressing.
Regarding the second perspective of "fund intermediation functions among entities," with the rapid scale expansion of sustainable investment, accumulation of empirical research on the impact of such investment behavior on asset prices has progressed. The impact of investment considering ESG (environmental, social, governance) factors on markets is complex, with various phenomena observed such as the existence of green premiums and occurrence of brown discounts. However, for sustainable investment to increase effectiveness and support transition to a low-carbon society, many challenges exist including incentive design for issuing companies, data development, and standardization of evaluation criteria.
Regarding the third perspective of "intertemporal resource allocation functions," it surveys major approaches to social discount rates including normative, empirical, and sustainability approaches, organizing discussions on optimization of resource allocation in long-term climate change countermeasures. Setting social discount rates is an extremely important element in economic evaluation of climate change countermeasures, becoming an important point in balancing consideration for future generations with current economic efficiency.
Throughout the research, recent climate finance research commonly shows with market participant surveys that incorporation of climate change risks into asset prices is insufficient. It also highlights that expansion of ESG investor base and data development are important future challenges. Keywords include climate change, physical risks, transition risks, sustainable investment, asset price evaluation, and social discount rates, with deepening research in these fields expected.
The article concludes that both financial practice development and finance research knowledge accumulation are hoped to work together for financial markets to play an important role in climate change response.