Pricing Climate Linkers
Jean Paul Renne, Université de Lausanne
We define climate linkers as long-dated financial instruments–bonds or derivatives–with payoffs indexed to climate-related variables, e.g., temperatures or sea levels. We develop an integrated assessment model (IAM) and use it to study the cost and risk characteristics of these (hypothetical) instruments. Climate linkers’ prices would embed climate risk premiums: because of the insurance provided by a bond indexed on temperatures (say), investors would demand a lower return on such a bond than on conventional bonds. Our findings highlight the sensitivity of these premiums to the assumptions regarding climate-induced damages.