Climate Risk and Volatility: Implications for Financial Markets

Temperatures are gradually rising, but even more concerning is the increase in the frequency and intensity of extreme weather events.
Modelling temperature volatility is an important issue in weather derivative markets. The weather derivatives market is still largely illiquid in Australia, but is expected to grow as climate risks are becoming more prominent. Since the late 1990s, energy companies in the US already started to used weather data as the basis for risk indices. In 1999, the Chicago Mercantile Exchange (CME) began trading weather derivatives. Modelling temperature volatility is now the topical issue for pricing and hedging on the derivatives market. As climate change risks are rising, investors are becoming more concerned about carbon bubbles and stranded assets in financial markets. Risks result not only from carbon constraints (e.g. limits to fossil fuel extraction and carbon constraints) but also changing technology landscapes and social expectations)