Exploring new economic models to measure risk and uncertainty for industries effected by climate change

By Sarah Fister Gale

Many academics at the University of Chicago are interested in climate change and how to manage the effects of this looming environmental disaster. But few approach this issue like Mike Barnett. Barnett is a fifth year PhD student in the six year Joint Program in Financial Economics in the Division of the Social Sciences. Early on in the program, he recognized a link between asset pricing and the potential impact on climate change behavior in energy economics. “It’s an interesting framework to quantify risk and how things are valued in an uncertain world,” he says.

He began working on research related to asset pricing and its relationship to climate change in his second year of the program under the guidance of his advisor,Lars Peter Hansen, the David Rockefeller Distinguished Service Professor in Economics, Statistics and the Booth School of Business; Director, Macro Financial Research Initiative. “As a research assistant under Lars, I got to explore interesting questions which turned into further research.”

Working with Hansen, Barnett contributed to joint research on Pricing Uncertainty Induced by Climate Change,which argues that the only way to engage in credible climate change policy analysis is to first acknowledge that we don’t fully understand how human inputs impact climate. Hansen has presented this research in several seminars and presentations, including the 11th Financial Risks International Forum held in Paris in March. Barnett also provided feedback on Hansen’s 2017 paper, Wrestling with Uncertainty in Climate Economic Models, which uses insights from decision theory under uncertainty to explore challenges related to researching climate economics.

Missionary with a mission

Barnett has spent the bulk of his time at UChicago focused on the economics of climate change, though he notes that he didn’t begin his academic career with aspirations to study climate change – or finance.

As an undergrad he studied economics at Brigham Young University, than took time off to be a missionary in Argentina. It was there that he became more attuned to the economic and financial differences that exist in the world. “Things that are secure here were out of control there,” he says. He points to things like the rapid rate of inflation and lack of job security in other nations. “We take for granted how our financial system works.”

When he returned, he spent two years working at the Federal Reserve as a research assistant, where he got to do policy research and build financial models for healthcare and fiscal policies.  The hands-on work spurred his interest in economics and finance, and ultimately led him to the financial and economics program which is jointly run by Chicago Booth and the Department of Economics.

Barnett had little formal training in finance, but early in the program he took several core classes, including an economics class that covered asset pricing, and he was quickly hooked. “As soon as we got to that part of the class, it made so much sense to me,” he says. “I knew it was what I wanted to do.”

He notes that companies already have well established methods to assess risk related to stocks, commodity pricing, and workforce management. “Those same tools can be applied to the climate change model,” he says. Energy companies in particular face numerous risks related to climate change, including whether they will be able to access to new fossil fuel sources, the potential cost of policies and regulations governing climate change, new competition from alternative energy producers, and consumer demand for clean energy. “Uncertainty in the climate model is an additional source of risk that many people don’t think about,” Barnett says.

Much of the work he has done with Hansen explores the impact uncertainty has on accuracy in climate models, and by what means businesses and governments might quantify that impact.

Risky decisions

Barnett is currently taking the lead on a research project that looks at the implications of climate change on stock prices for various types of energy companies, and how business leaders might use this data to make more informed decisions about how to mitigate risks in their portfolios.

Barnett notes that while some companies may mitigate risks by fast tracking mining and sale of fossil fuels to generate the most profits possible, others may respond by diversifying to greener options. While his unique academic focus could lead him to a career in the energy sector, helping these business leaders make such decisions, he believes he will stay on an academic path. “There are so many new problems to think about related to climate change and risks,” he says. “I’m a lot more interested in asking the questions than offering opinions on how people should act.”