Abstract
This paper makes a case for climate linkers. We define climate linkers as long-dated financial instruments (bonds, swaps, and options) with payoffs indexed to climate-related variables, e.g., temperatures or carbon concentrations. Such instruments would facilitate the sharing of long-term climate risks. Another key benefit would be informational, as the prices of such instruments would reveal real-time market expectations regarding future climate. We develop a tractable climate-risk pricing framework and exploit it to study climate-linked instruments’ cost and risk characteristics. We examine, in particular, climate risk premiums: because of the insurance provided by a bond (positively) indexed on temperature, investors would demand a lower average return on such a bond than on conventional bonds. Our findings highlight the sensitivity of climate premiums to the assumptions regarding damages associated with temperature increases and feedbacks between temperatures and emissions.
Published Version
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call