DATA 541 Flashcards

Managing Environmental Financial Risk

Identify linkages, Model the linkage, Characterize the Risk, Develop Instruments, Quantify Underpriced risks

Financial Risk is a function of

Linked Systems

Hazard

Changing Climate: Streamflow, Temps, Infectious Disease

Question for Hazards

How often and severe are the damaging events

Exposure

Changes to assets: Housing stick, electric power systems, computer systems

Question for Exposure

What is the value of assets at risk from these events?

Vulnerability

New Infrastructure: Dams Levees, Electricity Markets, Healthcare treatments

Question for Vulnerability

How vulnerable are the assets at risk to losses/damages? What actions or systems mitigate the damages?

Order of Linked Systems

Hazard → Exposure → Vulnerability

Risk Reduction

The probability of suffering losses goes down by building infrastructure, having drought pricing schemes, and retrofitting houses

Risk Retention

You have savings to compensate loss, but there’s a high opportunity cost. Reserve funds

Risk Transfer

Risk Pools and Reinsurance → you pay someone to take the risk off of your hands

Which management strategy is best for infrequent but catastrophic events?

Risk Transfer

Index Insurance

We want to insure against things that are very correlated with financial damages so that there is quick payment. A lot of information is always better

Index Based Financial Instruments

A buyer pays a seller for covered losses in exchange for a payout when there is a disaster or indexed (predicted)

Advantages of Index

Lower transactional costs, fewer “moral hazards”, quick resolution of claims

Index contract structure

Similar to a “put” option

Formula for Premium

Price = Expected Payouts + Loading

Loading

Opportunity cost of capital, R&D, and admin costs. Its the “cost” of risk management to buyers, doesn’t come back in payouts

Sitting on a million has a higher loading than sitting on a thousand?

True

Where is the ideal place to insure?

Avoid insuring only places that have disasters happen at the same time

Hedonic Property Values

Statistically estimating unknown home prices based on attributes from which value from sales and attribute data

Kriging

Estimating additional home value increasers

Loan to Value Ratio

Loan Balance/Property Value x 100 → borrowing to finance flood repairs raises debt and depresses property value

Do different states face different challenges?

Yes

Natural Disasters are related to each other?

True

Impacts of Financial Risk

Default/Bankruptcy, Lower valuation of a firm due to large swings in return, higher cost of financing

Do we care about modeling climate change?

No

Two kinds of risk

Physical Risk and Transition Risk

Physical Risk

Actual physical damage done to infrastructure

Transition Risk

Regulatory decisions caused by moving to net zero

Who determines what the risk is?

The Credit Rating Agencies; constantly need more information

Who provides flood insurance typically

The Federal Government

Systemic Risk

The risks are correlated in a large city. Building materials is a systemic risk after a large weather event. The 2008 Financial Crisis was a systemic risk

What is the primary way we manage risk in terms of surface water?

Resevoirs —> Which have slowed in construction

What typically ensures reliability for resevoirs?

Surplus capacity: Durham resevoires have a lot of surplus capacity

Synthetic Record

When we don’t have enough data, we can use historical record to make predicitions to expand our data.

Are consumption based revenues higher than consumption based costs?

True

How do utilities see financial risk

Utility companies are extremely risk averse. They will avoid uncertainty even for less profit.

High weather damage tends to lead to higher likelihood of defaulting?

True