In his keynote address at the 2015 Boston Security Analysts Society Sustainable Investing Seminar, Bob Litterman discussed assessing climate change in a risk management framework. Where an economic assessment of risk only prices expected damages, a risk management assessment considers worst-case outcomes. Worst-case climate change outcomes have a high level of uncertainty, which, in risk management terms, demands a risk premium. Today, the use of fossil fuels is subsidized worldwide, effectively creating a negative risk premium. A significantly higher price on emissions is required to generate the positive risk premium that will drive investments to avoid the worst outcomes.
In this interview with Bob Litterman, he discusses the following:The informational value and efficiency of incentives assessing the appropriate level of incentivesThe role of both markets and policy in creating effective incentivesThe aviation industry’s potential role in creating a globally harmonized price for emissions, set to reflect the economic externalityHow market prices are responding and highlighting the problem of stranded assets How one organization used a derivative structure to hedge climate risk, concluding that pricing emissions appropriately will reduce uncertainty, thereby freeing up a significant amount of capital to invest in new sources of energy