Storm Front

Climate change is the largest unhedged risk in the world, write Daniel Bloch, James Annan, and Justin Bowles

As climate change progresses over the coming decades, a widening range
of sectors will experience climate change-related damages. Climate outcomes, however, are subject to a high degree of uncertainty due to not only the socio-economic dynamics of different CO2 emission paths but also climate sensitivity to existing and future levels of CO2 in the atmosphere. In
the face of such uncertainties, states, industries, businesses, and individuals
can adapt to climate outcomes, mitigate their CO2 emissions (voluntarily
or under regulatory duress), or a combination of the two. The costs of
both adaptation and mitigation are, however, high, thus introducing a significant degree of risk associated with different potential climate outcomes.

Other than through the incidental establishment of a catastrophe bond market to manage weather-related events like hurricanes, the derivatives
markets to date have provided few if any tools to allow for the management
of climate-related risks. The authors believe that it is possible to create a variety of instruments such as the climate coupon bond presented below that tackle the unique underlying, maturity, and hedging-related challenges posed by climate change.Further, project managers are already taking multi-billion dollar climate change-related risk decisions today and the sums involved will inevitably expand into the trillions as climate change progresses. Thus, the need for such instruments appears pressing.

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