V. Physical Risks of Climate Change in Asset Markets Flashcards
Has the number of billion dollar climate disasters been rising over time?
Yes, in recent decades, we get more big billion dollar events.
However, hard to interpret strictly causally because
- US has been getting richer
- People increasingly love living in disaster zones.
- People move to oceanfront because governments subsidize flood insurance
Key Conclusion
–> Graph helps pitch that there is climate change.
–> Is Katrina in 2005 (as an outlier) a bad luck event or has the distribution shifted? How much should I learn from this graph? Should I argue we had bad luck in 2005 and 2017? You would like to weigh this.
Is there major uncertainty on projections for disasters such as cyclones?
In the Emmanuel model,
Typical forecast is about 20% more frequent for very intense cyclones. Right tail is like 60% more.
–> Even within one model alone there is a lot of standard deviation and uncertainty.
–> SO IT’S NOT CLEAR HOW MUCH YOU SHOULD UPDATE YOUR BELIEFS.
In a no-learning environment, how often does an individual in a typical country expect a cyclone to hit?
Based on Column 3, 13% of country sample period observations experienced a cyclone that made landfall
1/0.135 = 7.5. Therefore, typical country experiences cyclone hit every 7.5 years.
What is the empirical impact of a storm arrival on GDP growth?
Results find that after being hit, GDP growth in the following year will be lower by 77bps (approx. 1%)
But, limitation is that interpreting beta relies on parallel trend assumption. Yet, countries are getting hit all the time and being knocked off trend.
What do our empirical damage estimates suggest about the learning channel?
If there was no learning, disasters would destroy capital stock, but the underlying long-run growth prospects would not change. Therefore, we must consider belief updating and views of elevated risk after landfall.
How does the empirical evidence seen in class relate to these four hypotheses?
Graph is recovery of growth rate.
The evidence is that in class we saw evidence between no recovery and recovery to trend. It’s hard to know because recovery to trend might take 10, 20, 30 years.
Local GDP may have recovered to pre-event level but that doesn’t mean the growth rate is the same.
Explain the following of the four hypotheses that describe the long-term evolution of GDP following a natural disaster.
“Creative Destruction”
Disasters can be good because they unleash the potential for progress previously held back - incumbency.
No evidence.
Cannot be this hypothesis because capital was destroyed which explains early dip.
Explain the following of the four hypotheses that describe the long-term evolution of GDP following a natural disaster.
“Build Back Better”
Associated with having older capital which when destroyed presents opportunity to have better capital.
ASSUMES no-learning.
To want to rebuild and re-exploit the area economically in the same way you did before requires no change in beliefs.
Explain the following of the four hypotheses that describe the long-term evolution of GDP following a natural disaster.
“Recovery to Trend”
Also assumes no-learning. probability of a disaster hasn’t changed.
If nothing has changed, it’s still optimal for people locally and investor to just rebuild capital and go back to trend
Explain the following of the four hypotheses that describe the long-term evolution of GDP following a natural disaster.
“No Recovery”
The only way we are in a no-recovery zone is if beliefs have changed and people are now judging the location differently. They are judging it more risky and will be less aggressive about investing. Furthermore, it may be harder for countries to borrow money to rebuild as a result.
Define Tobin’s q
Value of stock market is q * K, where K is book value of capital
q of most things we look at is 2.5.
Uncertainty and Difficulty for Financial Markets to Price Assets
ONLY when the risk is obvious/well identified is it priced into markets. So this means financial markets are ex-poste efficient but not good in anticipation of any risks. Rely on impacts.
IF NOT, with all the uncertainty we have right now, it’s likely that financial markets find it very hard to price these things.
Not sure what climate scenario we have when you’re lending.
So in this case, investors tend to learn and update beliefs whenever events happen.
Define Learning
Process by which agents update their beliefs about how any given location will be affected by global warming and over time through realizations of events.
If the bad state doesn’t happen, agents become more optimistic
Define Hedging
What do people do to minimize impact of this climate risk.
In the set of problems we’re discussing, we need to rely on real hedging and make offsetting investment decisions.
Weather vs Climate
Weather is one realization of the underlying climate.
Climate is a probability distribution over all possible weather events. When it happens either it’s just a realization of that or the distribution has changed.
