Climate change news, politics, and investors
Investment decisions linked to climate change news is not hedging climate risk, it is constructing the political spectacle.
This is related to a previous post on the Office of Financial Research (OFR) that sits under the Treasury and serves the Financial Stability Oversight Council. In that post, I said it would be the first in the series. So, let’s call this post the second installation.
In September 2022, the OFR held a virtual conference on climate related risks and financial stability. In looking over the conference agenda I was drawn to the paper session on Climate Stress Testing by Robert Engle (NYU), Hyeyoon Jung (Fed Reserve of NY), and Richard Berner (NYU).
I skimmed the paper not looking for anything in particular. But, two statements caught my attention:
“There are several ways to measure the climate risk factor, including the climate news index constructed by Engle et al. (2020)”
mention of Bob Litterman
Number 1 is the subject of this post. Number 2 will likely be the subject of a later post.
Robert Engle is a Professor Emeritus at NYU and Noble Prize winning economist known for his work in modeling volatility that supports tools for arbitrage. He recently took an advisory position with Climate Finance Partners replacing John Kerry when named Biden’s Special Presidential Envoy for Climate. Climate Finance Partners is a carbon trading investment firm working towards a global price for carbon.
Engle is also co-Director of the The Volatility and Risk Institute. He shares this leadership with Richard Berner, who, among his many accolades, was (wouldn’t you know it) the first director of the Office of Financial Research from 2013-2017, an appointed position.
Engle et al (2020) uses news coverage as metric for measuring climate risk. But news is massaged- in content and quantity- to shape public perceptions. Reporting frequency isn’t really a measure of realized risk but rather a proxy for public perception or political fervor.
Risk perception is ‘socially constructed.’ How we understand risk and what risks we pay attention to is a reflection of our politics, culture, worldviews, etc. All these factors also influence what we read. While what we read influences our risk perception. Which is how many end up in echo chambers, doom scrolling in horror.
Public concern for issues- climate change, election fraud, or otherwise- can be intentionally shaped by the political elite such as, elected officials, mainstream news, advocacy leaders.
One way of shaping news coverage is by timing the release of major scientific reports and congressional hearings with upcoming policy (and business events) so as to drum up media attention, which in turn influences public concerns.
Another way is to fund events in partnership with elite news outlets, like Morgan Stanley and the New York Times. Still others politically and financially invested in climate change politics run their own media outlets.
Likewise, political events will influence what science shows up in the media. The dynamic is said to influence exaggeration in science and vice versa. Written in Nature some years ago, it was commented that,
Exaggeration will persist in the news cycle only if it benefits all those involved — from the scientists who can count press coverage as ‘impact’ to the reporters who bag another high-profile byline and the approving comments of their bosses.
There is not a clear divide between science, politics, and policy. It all interacts.
Engle et al (hereafter as E20) observes that investors are influenced by the news they consume. They write,
We start from the observation that when there are events that plausibly contain such information about changes in climate risk, this will likely lead to newspaper coverage of these events; indeed, newspapers may even be the direct source that investors use to update their subjective probabilities of climate risks.
And, presumably related to E20’s observation above, headlines filled with hyperbole on weather disasters and climate change can drive profitability in certain investment areas like catastrophe bonds. According to John Seo of Fermat, who (wouldn’t you know it) is also an advisor to the Treasury’s Federal Insurance Office,
“That’s really our greatest opportunity for alpha generation because it’s not the media’s job to calibrate the message around the threat of natural catastrophes.
“They’re reporting on it in a way that has, frankly, an element of entertainment to it, but not measure, and that can cause extreme discrepancies between prices of bonds in the secondary and even in the primary market versus reality,”
E20, “Hedging Climate Change News,” (non-paywalled pre-print, published) aims to provide information to investors “to hedge against the realizations of climate risk” or more specifically, a “climate disaster,” whatever that may be exactly.
The authors use climate change news coverage in the WSJ to construct a “WSJ Climate Change News Index” to hedge the realization of climate risk. The image below shows that news spikes around policy events, scientific assessments, and other events (e.g. Climategate).
E20 recognized an implied assumption,
Implicit in our construction of the WSJ Climate Change News Index is the assumption that the number of climate change discussions increase when climate risk is elevated. In other words, the WSJ index embeds the view that, when it comes to climate no news is good news.
But the bigger assumption is that the news reflects climate risk- at all.
The major peak in the graph above around 2009/2010 is, according to the authors, driven by Climategate and COP15. Climategate put climate change science’s dirty laundry on display for all to see; everyone had something to say about it. COP15 is notable for the general collapse of the Kyoto Protocol. Kyoto was basically an investment regime that lives on in the inspiration of activities such as that by Climate Finance Partners.
If there was any realized risk of these events it was reputational, political, and/or regulatory. It was not climate risk.
Now, it’s not that weather disasters cannot drive headlines. They do, very much so. And weather is related to climate. Some climates produce hurricanes and others do not.
So, hurricane disasters for instance, can be considered a realization of climate risk. It is also the case that weather disaster stories are often connected with claims of the realization of climate change.
But hurricane disasters are a product of the society. And the extent to which hurricane behavior reflects climate change is debated. So, again, using climate change news as a proxy for the realization of climate risk is inappropriate.
The late political scientist Murray Edelman is well known for his work Constructing the Political Spectacle. Edelman approached political news of “as creations of the publics concerned with them.” As a result,
The political entities that are most influential upon public consciousness and action, then, are fetishes: creations of observers that then dominate and mystify their creators.
E20 extends the benefits of the news cycle long enjoyed by the political elite to the financial elite. And (wouldn’t you know it) the two groups overlap; in some cases, producing the news they benefit from.