New research by Viral Acharya, an economist at New York University, attempts to measure the extent to which these costs are already reflected in the price of stocks, corporate debt and municipal bonds. The researchers found a significant impact of heat stress exposure on all three. I spoke with Acharya and one of his co-authors, Tuomas Tomunen, assistant professor of finance at Boston College. A condensed and slightly edited transcript of the conversation follows. Their paper, which was co-authored by Suresh Sundaresan of Columbia University and Timothy Johnson of the University of Illinois, can be found here.
Jonathan Levin: What were your main lessons?
Viral Acharya: The first finding is that across all markets, the physical climate risk that appears to be valued – both statistically and economically meaningful – is exposure to heat stress. Second, we find that economic quantities are quite important when you normalize the distribution of physical climate risk across municipalities or firms. About one standard deviation of change seems to contribute, in the case of municipal bonds, something in the order of 15 to 20 basis points [per annum in muni bond yield spreads]. In the case of sub-investment grade corporate debt, something in the order of 40 basis points. And in terms of the cost of capital in issuing shares, it’s also something in the order of 40 basis points per year. While not earth-shattering, I would say these are still respectably large quantities that we have attached to physical climate risk.
JL: Has the market always perceived the additional risks linked to climate change?
VA: The pricing of physical climate risks appears to be more consistent both economically and statistically – at least in the data and using our methodology – from about 2013-2015, depending on the test and the markets we examine. There can be several reasons for this. One could be that the risk of heat stress has actually increased in the recent past, and the manifestation of this risk in municipal and corporate cash flows has led the market to price this risk.
JL: What about greater investor awareness of future risks?
VA: Maybe the risk has always been there, but somehow, with the activism of investors, multilateral agencies, think tanks, NGOs, etc., there may be -be learning and greater awareness of these risks on the markets. Either way, the fact that these risks are priced more for sub-investment grade companies, the fact that they are priced more recently, and the fact that they are priced more based on stress thermal rather than risks such as hurricanes or drought in which adaptation might be an easier possibility obstacle, we believe that all of this gives us reasonable confidence that we are capturing what looks like a pricing of climate risk physical.
JL: Can you explain what investors might be thinking by demanding higher risk premia for these securities?
VA: Ultimately, our measures of physical climate risk are measures of expected losses for these companies. For example, at the county level, what would be the impact on the productivity of employees in high-risk industries such as construction and mining, where thermal stress would make their job very difficult? Even though there are mitigation strategies such as air conditioning, these would significantly increase your energy expenditure. These are losses that should be incurred, and they will impact your cash flow.
JL: Tell us how physical climate risk specifically affects municipalities.
VA: In the case of municipal debt, where we think adaptation isn’t really feasible — you can’t change the location of the municipality — we think it’s natural that the impact is there. We anticipated that the munis would show the pricing of physical climate risk. We find even in the case of munis that the effect is stronger for sub-investment grade debt, but interestingly it is also stronger for longer-term debt because you would expect climate risk to be much like disaster risk, which increases in its accumulated frequency of occurrence over a long period of time. And we also find that pricing is stronger in income-only bonds than in general bond bonds – general bond bonds have a more diversified pool of cash flows.
JL: And companies?
VA: Companies can move their locations. They can shift their sales, employment, and production intensity to different factories. Yet what we find is that under heat stress, despite the possibility of adaptation, especially for sub-investment grade debt, the effect of being exposed to heat stress is quite important. Now, we don’t find a similar effect from other physical climate risks such as exposure to hurricanes, like being on the coastline, or being exposed to certain areas of flooding and drought. We think one of the reasons for this result might be that it’s not that hard to move your plants from being on the coast to, say, a bit inland, whereas the exposure gradient to heat stress moves very slowly geographically. There are only large pockets of states in a collection that are somehow all exposed to heat risk. Now you have to completely change your location. Sometimes it can even mean fundamentally changing your business model. Like if you’re an agricultural business in the Midwest, it’s not like you can just move to the Northeast, for example.
JL: And why do you think physical weather risk is more sensitively factored into riskier stocks?
VA: There seems to be an impact on cash flow which then affects the probability of default risk. And where is it most important? This matters most for businesses that are already poorly rated to start.
JL: Can we just find a cheaper way to provide air conditioning or find a way to cool and shade construction workers to keep them healthy and productive?
VA: The cheap way of providing air conditioning is also not very emissions-friendly. So the move away from chlorofluorocarbons means air conditioning has also become more expensive in some sense.
Tuomas Tomunen: Air conditioning is kind of like the one big way that humans are going to adapt to climate change, but the consequence of the actual increase in cooling is exactly what a lot of the climate science literature ultimately thinks is the most expensive cost of climate change. once you take into account this type of adaptation. Of course, if we could find a renewable, inexhaustible source of energy, this problem would probably go away, but to the extent that we can’t, there doesn’t seem to be an easy solution to this kind of increased demand. energy. .
JL: Is there an example of what the real world heat stress costs look like today?
VA: These things get pretty interesting in a world where power and fuel are going through very big increases simultaneously. For example, in an emerging market like India, where I come from, every summer there is a very heavy load on power sharing in the country. Temperatures in cities like New Delhi reach 40 degrees Celsius (104 Fahrenheit), which invariably leads to huge coal imports and even more thermal power generation. … And finally, what we observe in a country like India is that for weeks, schools sometimes have to be closed, offices closed. There are times of the day when the factories are not allowed to operate because at that time the consumption of air conditioning is very, very important in the economy. What I’m trying to say is that once you’re in a situation where something else is going on in the background, like a power shortage or fuel prices are very high, these climatic shocks can really exacerbate mitigation and adaptation strategies at that time. indicate.
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Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.
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