Importance of Natural Resources

Researchers Propose New Method to Hedge against the Risk of Climate Disaster

(gentle bells chiming) – Climate change has become like a much more recognized issue. And I think financial markets are also now starting to recognize it’s a major issue. And we just don’t have many tools that allow us to manage this risk. So for example, for many other risks like many micro risks, for example. We have derivative markets
that allow us to really manage the risk and transfer
the risk around the economy. But for climate change, we don’t. And so, I think that there’s
a lot of work to be done in order to understand
financial markets can help in providing solutions to climate change and the problems that come with it. – To the extent that there’s
this pervasive desire to hedge climate risk
throughout the economy, then this has interesting
equilibrium ramifications. Prices should start to
reflect peoples’ desire to hold assets that payoff
when climate risk is high. And this is exactly the resource reallocation function of markets. If everybody’s now
interested in doing this, finding these assets that appreciate when climate risk is high
and climate outcomes are bad, well then, the prices of those
assets are going to rise. And if everybody’s
interested in selling assets that tend to do poorly in
these bad climate outcomes, they’re especially climate
exposed, well then, people are going to be selling
those assets up front, now. So these types of assets,
think of it as maybe a coal producing firm, these are going
to start to lose value now. They’re going to be
unattractive investments today. Which is just the economy’s
way of reallocating resources to these projects that are actually, in the long run, mitigating climate risk. So this, by hopefully making
some of this hedging benefit more accessible, we would
hope that prices sort of equilibrate more
efficiently to reflect the collective demand for less
climate risk investments. – We don’t understand the effects of climate change on the economy. We don’t understand how our
actions effect climate change. We don’t understand whether
we’re going to be able to adapt or mitigate climate change. So there’s so much uncertainty
about the underlying process. And so, it’s almost impossible for anyone to figure out what to do. Which in turn, is one of the
main issues with thinking about constructing a
market for climate change. – Yeah, this is a different
problem than most types of risks that financial markets are
sort of well-suited to hedge. In the sense that it’s a
risk that is very tough to detect and it’s very long dated. The bad consequences we
expect to be, sort of, much further out in the
future than the typical risks that we’re used to hedging
in the financial market. Right? You think about the financial market, it’s well-suited for
investors that are trying to, essentially, trade on
and hedge against things that are sort of like business cycle risk. So think about fluctuations that happen every two to three years,
or more frequently. And now, we’re talking
about a risk where some of the worst outcomes might
be 50 years or more off. So not only are they very hard to measure, it’s had to think about
how you feel about things that are going to happen
in such distant future. We start to have to worry
about issues that you wouldn’t consider about with a lot of
normal stock market risks, like, how do I feel about
my descendants’ well-being? Right? This is something that comes into play when you’re thinking about climate risk.

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