Which tool is commonly used for assessing climate risks in financial portfolios?

The correct answer is climate scenario analysis models. This tool is essential for assessing climate risks in financial portfolios because it allows financial institutions to evaluate potential future climate-related changes and their impacts on investments. By modeling various climate scenarios, organizations can analyze how different trajectories of climate change—such as temperature increases, regulatory changes, or shifts in consumer behavior—might affect asset values, cash flows, and overall portfolio performance.

These models help in understanding both the physical risks associated with climate change (like extreme weather events) and the transition risks related to the move towards a lower-carbon economy. As such, they provide a structured approach to integrating climate risk into the investment decision-making process and can significantly enhance risk management strategies.

Other options, while relevant to risk assessment and management, do not specifically target climate risks in the way that scenario analysis does. For instance, market trend analysis might look at general economic conditions but lacks the specific focus on climate-related factors. Risk-adjusted return analysis primarily assesses investment performance in relation to risk but does not evaluate climate-specific risks explicitly. Portfolio diversification strategies can help mitigate overall risk but do not inherently address the unique challenges posed by climate risk.