Climate-linked financial crises loom, but the fix isn't up to central banks

phys.org | 9/2/2019 | Staff
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The Bank for International Settlements—the "central bank" for central banks—made headlines this week with a report outlining how the next major financial crisis may come from unexpected climate risks.

The book calls these risks "green swans"—a play on the term "black swan," coined by author Nassim Nicholas Taleb. Black swans, Taleb writes in in his 2007 book, are events that are highly improbable, wide-ranging or extreme in their impact and can typically only be explained after they occur.

Example - Markets - Investment - Strategy - Hedge

An example in the financial markets is how the supposedly risk-free investment strategy of the hedge fund Long Term Capital Management in the late 1990s spiraled out of control and nearly took down the global financial system.

Green swans are the climate-related equivalent of black swans.

Analogy - Features - Swans - Techniques - BIS

This is more than just a cute analogy. One of the defining features of black swans is they cannot be modeled using standard mathematical techniques. As the BIS report puts it: "Black swan events can take many shapes, from a terrorist attack to a disruptive technology or a natural catastrophe. These events typically fit fat-tailed probability distributions, i.e. they exhibit a large skewness relative to that of normal distribution (but also relative to exponential distribution). As such, they cannot be predicted by relying on backward-looking probabilistic approaches assuming normal distributions (e.g. value-at-risk models)."

Climate risks have the same features: "Climate-related risks typically fit fat-tailed distributions: both physical and transition risks are characterized by deep uncertainty and nonlinearity, their chances of occurrence are not reflected in past data, and the possibility of extreme values cannot be ruled out."

Swans - Swans - Climate - Science - Effects

Where green swans differ from black swans is that, given what we know about climate science, it is highly likely there will be extreme, financially devastating effects.

Australia's recent bushfires are a notable example of the more frequent extreme events expected. In the United States, there...
(Excerpt) Read more at: phys.org
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