Climate Finance

Question 1

Describe the large negative effect of fossil fuels on economic growth.

Answer 1

Fossil fuels are a critical input to production, so economic growth generates an increase in greenhouse gas emissions. These emissions induce climate change and climate change can have a large negative effect on future economic activity.

Question 2

What are three financial aspects of climate risk?

Answer 2

Pricing and hedging risks of climate change
Awareness and attitude of investors towards climate risk
Effect of climate risk on investment decisions

Question 3

What are two forms of risk in climate risk, give an example of each?

Answer 3

Physical risk (droughts, floods, wildfires) and transition risk (costs of transitioning to a low-carbon economy)

Question 4

Do physical risk and transition risk occur at the same time? Give an example to explain.

Answer 4

No, they do not occur at the same time but they are often correlated. For example, the carbon tax. It increases transition risk because it incurs costs but it reduces physical risk but it reduces emissions.

Question 5

Name two reasons for a lack of credible measures for climate risk.

Answer 5

Firms are reluctant to share their risk exposure.
Climate risk is ever evolving.

Question 6

What are four types of data to measure climate risk exposure?

Answer 6

Earnings call transcripts
Financial data
Textual information in company filings
Other external firm data like ESG ratings

Question 7

What are two types of physical risk?

Answer 7

Acute physical risk and chronic physical risk

Question 8

How to measure climate risk exposure using earnings transcripts?

Answer 8

Develop climate-related keywords and measure climate risk exposure as a share of keywords in earnings call transcript

Question 9

Which two sectors are most affected by climate risk?

Answer 9

Agriculture and utilities

Question 10

What are three observed reactions of firms to higher transition risk exposure?

Answer 10

Leads to higher investments for proactive firms.
Leads to higher R&D and green patents for proactive firms but less R&D for nonproactive firms.
Leads to lower employment stock for nonproactive firms.

Question 11

What are two reasons that firms are voluntary committing themselves to climate targets?

Answer 11

To signal effort towards climate risk to the market to increase market share.
To anticipate future regulations.

Question 12

What is a negative consequence of a lot of decarbonization commitments?

Answer 12

Greenwashing

Question 13

What is greenwashing?

Answer 13

Pretending to be greener than you are.
(Volkswagen, Toyota, Goldman Sachs, Deutsche Bank, Decathlon, H&M)

Question 14

How does funding react to emissions and decarbonization targets?

Answer 14

Higher credit risk ad higher emissions lead to higher interest rates.
Decarb. targets lead to lower interest rates.

Question 15

How does a natural disaster effect physical risk?

Answer 15

It obviously increases physical risk measures

Question 16

Is transition risk priced in stocks?

Answer 16

Yes, higher transition risk leads to a lower Tobin’s q, which is a measure for firm valuation.

Question 17

What are two reasons for the fact that 56% of firms are underperforming towards their decarbonization target?

Answer 17

Aggregate shocks in society (energy crisis)
Overpromising

Question 18

What are five ways to incentivize firms to realistic commitments?

Answer 18

Stress-test commitments before announcing them.
Make state-contingent pledges.
Consider the uncertainty of green technologies.
Set interim targets and tie them to management compensation.
Link the cost of capital to the decarbonization targets (for example, through sustainability-themed bonds where the coupon payments go up when the targets are not met)

Question 19

How should we price CO2 emissions?

Answer 19

Using carbon tax and subsidies to green innovation = carbon pricing

Question 20

Describe the results in Sweden, where the highest carbon tax is used.

Answer 20

In Sweden, a higher carbon tax leads to lower emissions.

Question 21

Describe three potential solutions to reduce carbon emissions for companies.

Answer 21

Change in technology
Change in composition
Lower output

Question 22

Which industries in Sweden are being taxed on carbon?

Answer 22

Transportation (mobile) and energy (heating)

Question 23

How do Pollution Abatement Costs (PACE) and asset mobility influence the effect of carbon tax?

Answer 23

Industries with higher costs to reduce pollution are less reactive to carbon tax.
Industries with lower asset mobility have higher costs to reduce pollution and are therefore less reactive to carbon tax.