Thursday, December 13, 2007

Betting On Climate Change (Climate Change Pediction Markets)

A new climate change prediction market has been launched. Here are the details on motivation and participation.

From VoxEU:

What will happen to global efforts to limit greenhouse gas emissions when the current commitment period of the Kyoto protocol ends in 2012? There are hopes that the United Nations (UN) climate change conference that started on 3 December in Bali will outline a road map for a successor agreement that might be reached in late 2009.

To know what is going to happen in 2012 and beyond is not only relevant for future generations but for a wide range of investment decisions today:

  • Should you buy that flat in a riverside building?
  • Should companies invest in R&D on carbon capture and storage technologies?
  • Should governments provide more money to wind farm development or rather improve flood defences and relocate people living close to the coast?
  • Should an energy intensive company relocate its production from an industrialised country to a developing country unlikely to be covered by a pollution target?

To make these choices wisely, we need forecasts on the likely outcome and design of any post-Kyoto agreement. There is no shortage of opinions on what is going to happen. But whom should you trust? Opinions will be influenced by wishful thinking and strategic positioning alike as well as being based on different insights into parts of the puzzle. For example, living in the rich world, you might have a good sense of what the typical voter in your country thinks about pollution targets, but what about Indian voters or the Chinese communist party?

If the UNFCC – the UN body in charge of the climate change negotiations – was a publicly listed company whose profits depended on the climate change reduction targets it achieves, a good way of getting an idea on what’s going to happen is to have a look at its share price rather than public statements of its bosses or shareholders. This is obviously not a possibility. But what is possible now might be even better.

Last week,, the Irish prediction market company, started trading in a range of financial contracts whose payoff depends on specific outcomes of a post-Kyoto climate change agreement. The contracts, which were designed together with the Centre for Economic Performance (CEP) at the London School of Economics, capture which countries will participate in a post-Kyoto agreement as well as how stringent any pollution reduction targets might be.

How does this work in practice?

All climate change contracts on the Intrade market are binary contracts. Consider, for example, the US.TARGET.DEC09>10% contract. If by December 2009 the UN negotiation process has led to an agreement that implies a 10% reduction target for the United States relative to 1990, this contract pays $10. This is good news if you bought such a contract for less than $10, because you have then made a profit.>>>MORE

HT: Common Tragedies