I just attended a good American Finance Association session featuring prominent economists talking about the finance aspects of global warming (discounting, risk aversion, fat-tailed risk, insurance, etc.) Present were Kent Daniel, Robert Barro, Rajnish Mehra, Lars Hansen, and Robert Litterman. In preparation, I drank half a cup of Starbucks after not drinking coffee for two months, so I am hyper enough to write up a blogpost. Below are three unrelated ideas the session stimulated, on university portolios as hedging carbon risk, carbon wars and revolutions, and the free-riding problem.
1. UNIVERSITY PORTFOLIOS AS HEDGING CARBON RISK. Here's the question I asked out loud, with elaboration. Bob Litterman said that WWF has gone short on carbon-intensive stocks, those that would be hurt by a carbon tax. He said that this was because the market currently underestimates the probability of such taxes, so he can beat the market. That's OK— with political and scientific issues like this, maybe he can. (Question, though: why is Wall Street so very wrong, when they have a lot of smart experts?) Then Bob Barro said he thought the reason to short was hedging, for insurance against high carbon prices. If carbon prices rise (or they don't, but warming hurts wealth severely and causes all stocks to drop), then carbon stocks will fall, but if warming turns out not to be a problem, carbon stocks will rise or stay the same. Thus, if the investor holds other wealth that will be hurt by high carbon prices or warming, he should hedge by shorting carbon stocks (also he should hedge because prices of consumption goods will go up).
But that's wrong, at least for university investors.