REUTERS/Wolfgang Rattay
- A study from Columbia University indicates that financial markets are pricing in climate risk into decision-making, which is having a major impact on investing.
- The paper studied trades made at the Chicago Mercantile Exchange (CME) that saw investors effectively bet on the number of hotter- or colder-than-average days.
- "The observed annual trend in futures prices shows that the supposedly-efficient financial markets agree that the climate is warming," the authors wrote.
When it comes to predicting climate change, traders in financial markets have been making profitable bets.
A new study from Columbia University calculated almost 20 years of trading in weather futures contracts on the Chicago Mercantile Exchange (CME), where investors effectively bet on the number of hotter- or colder-than-average days across eight US cities.
"The market has been accurately pricing in climate change, largely in line with global climate models," they wrote. "This began occurring at least since the early 2000s when the weather futures markets were formed."
The futures contracts are derived from measurements called "degree days," which can be calculated over periods of time. That can then be used for analysis like estimating the amount of energy needed for heating and air conditioning.
The contracts, at about $20 each degree day, are used to offset risk within markets or by speculators. For example, a citrus company may purchase a contract to mitigate the risk of a winter freeze, the study said.
The report outlined an example of a winning trade:
For context, if a trader buys one July "cooling degree day" contract for 300 CDDs, the cost would be $6,000.
"If the realized cumulative CDD for the month of July settled at 330 cooling degree days, the clearance value would be $6,600, and the trader would reap a profit of $600 ($20 times the increase of 30 degree days)."
The study, led by Wolfram Schlenker — from Columbia’s National Bureau of Economic Research — and Charles Taylor — a PhD student in Sustainable Development, controlled for short-term weather forecasting and periods of thin liquidity.
The impact of the findings have implications for finance more broadly. For the corporate sector, the stakes are high:
"Recent studies have highlighted how the valuations of companies and entire industries are sensitive to weather fluctuations. Efficient and profit-maximizing behavior requires an accurate assessment of predicted warming. Weather markets can provide companies with pertinent information on future weather and climate trends, as well as a hedge against potential lost profit."
As a result, traders — whose entire role depends on better understanding market forces — have aligned their pricing of buying or selling futures alongside academic research on climate change.
The study also suggests that while there are plenty of climate-change deniers around, they don’t seem to be putting their money where their mouth is.
"Anyone doubting the observed warming trend can make a significant profit by betting against it in weather markets," the study said. "However, the observed annual trend in futures prices shows that the supposedly-efficient financial markets agree that the climate is warming."
The researchers continued: "Climate models have been very accurate in predicting the average warming trend that’s been observed across the US. When money is on the line, it is hard to find parties willing to bet against the scientific consensus."
See Also:
- GOLDMAN SACHS: Here’s why the latest yield-curve inversion pales in comparison to past signals — and why you shouldn’t give up on the economy just yet
- CME’s CEO explains how Main Street is taking more control over its portfolio from Wall Street and how the futures exchange is adapting
- US companies are going public later and later and it’s having a major impact on investing
Source: Business Insider – cburroughs@businessinsider.com (Callum Burroughs)