The Price of Climate Risks - Bob Litterman презентация

real?

Is a devastating natural disaster outside the realm of possibility?

When, where, or how might a global catastrophe occur?

Does it matter how much carbon dioxide we put into the atmosphere?

Should adding emissions to the atmosphere be priced appropriately?

What is the appropriate price for emissions?

budget

Coal

Coal +
Oil

Coal +
Oil + Gas

Proven Reserves

Stranded assets 2230

Source: Carbon Tracker Initiative

none of our assets will become stranded

of carbon)

There are 2 kinds of risk:

High risk aversion

Low risk aversion

Zero

The price of climate risk today

Non-diversifiable
Risk

Diversifiable risk

Expected damage

risk
premium

= 4.75%

Stock real return = 6.4%

Bond real return = 1.6%

A consistent 475 basis points per year for the last 140 years

that pays off in bad states of nature

Data are from http://www.econ.yale.edu/~shiller/data.htm

An equally risky portfolio
long bonds and short equities earns
-310 basis points

Risk?

Pricing carbon emissions is a risk management problem involving trade-offs between consumption today and potential bad outcomes in the distant future

This trade-off depends crucially on the degree of societal risk aversion

Societal risk aversion can be calibrated to the equity risk premium

2012

a standard CRRA utility function

Counter to intuition, in the standard utility function increasing the risk aversion makes curbing emissions less urgent

Higher curvature has two impacts:
1) it increases the risk premium, but
2) it also increases the risk free discount rate

The second impact dominates and causes the price to decrease

Lord Nicholas Stern, for example, set a degree of curvature that implies an equity risk premium of around 12 basis points,

more than 30 times too low relative to observed risk premia

Estimates of the social cost of carbon
from Anthoff, Tol, and Yohe (2009)

emissions
prices

Increasing risk aversion

Why???

very
significant equity risk premiums
that we observe in the market

While lower intertemporal curvature
is required to fit the relatively
low risk free rates
that we observe in the market

Risk aversion

Intertemporal substitution

Epstein-Zin utility can be calibrated to both
high risk premia and low interest rates

consumption ( time, states of nature )

consumption ( time, states of nature )

utility

utility

models increased
risk aversion lowers the price of emissions

Plan

The Appropriate Price
Trades off current consumption against future damages
Recognizes unknown impacts, and the potential for time compression and catastrophic outcomes
Builds in a margin of safety
Anticipates risk reduction over time

Higher Risk Aversion
Increases the risk premium
Lowers the discount rate for future damages
Raises the price today and potentially lowers the expected future price

risk of catastrophic outcomes

forward prices will
be driven by the rate
of technological change
in emissions mitigation

assets e.g. coal and tar sands

Governance
Appropriate, transparent business plan assumptions about future emissions prices

Markets
Hedging requires a forward market in emissions prices

This recognition has implications for:

higher emissions prices)

Are they a risk or an opportunity?

Stranded assets will re-price to reflect changing expectations of forward prices, rather than changes in actual emissions prices.

corporate
forward expectations
from CDP survey

current forward curve?

return

S&P 500 index return

net total return 21.7%

1/3/2011 through 1/17/2014

Swap 21.7%

S&P 500 15.9%

Tar sands 2.0%

Coal -10.1%

A hedge which reduces portfolio risk

And adds a potential source of return

Better aligns investments with mission

Doesn’t impact underlying assets

seems to have no intention to create appropriate incentives

Aviation will need capacity to create emissions
requires high energy content of liquid fuel for takeoff and ascent
atmosphere’s capacity to safely absorb emissions is limited
thus aviation has a special incentive to lead on this issue

Owners of aviation shares have an important role to play
management often focuses too much on short term profits
long-term owners have longer term priorities, such as creating appropriate global incentives to reduce emissions