Just to take a break from the chaos at home, I would like to celebrate the recent achievements of Stefano Giglio, professor of finance at my Alma Mater, the Yale School of Management, whose work explores the impact of climate change on financial markets , won the Carlo Alberto Medal last month for his research in the field of economics. Professor Giglio’s contribution to the dissemination of economic knowledge among budding young minds actually dates back a long way to his tenure at Yale’s SOM. He has been on the faculty of Yale School of Management since 2017. Basically, he offers a new methodology for building portfolios that hedge climate change risks. His quantity-based approach explores how mutual fund holdings change when the fund advisor experiences a local extreme heat event that alters beliefs about climate risk. It uses observed trading behavior to predict how investors will reallocate their capital when “global” weather shocks occur, which simultaneously alter the beliefs and demands for assets of many investors and thus alter equilibrium prices. Essentially, showing that a portfolio that holds stocks that investors tend to buy after experiencing a local heat shock increases in value during periods of global climate shocks. Our quantity-based approach produces superior out-of-sample hedge performance compared to traditional methods of identifying hedge pools. The main advantage of the quantity-based approach is that it learns from cross-sectional trade responses rather than time-series price information, which is limited in the case of climate risks. It also demonstrates the effectiveness and versatility of the quantity-based approach in constructing successful hedging portfolios for aggregate unemployment and house price risk.
Created in 2007 by the Collegio Carlo Alberto, a private research and education institution in northern Italy, the Carlo Alberto Medal aims to inspire young Italian economists to “pursue their research activity with renewed commitment”. Each year, the me receives more than 350 nominations from around the world, and the winner is chosen by a selection committee made up of eminent economists. In 2021, the selection committee consisted of seven professors of economics, including Fabrizio Zilibotti from Yale. The award announcement recognized Giglio for his contributions to empirical asset pricing and his research on climate finance. “Yale (and in particular the School of Management) is an amazing place to do research,” Giglio wrote in an email to Yale News. “SOM’s finance group is not only a collection of great minds with acute intellectual curiosity and a diverse set of research interests, but it is also an extremely collegial group, where constructive feedback is the norm. I benefited enormously from this work environment.As explained above, Giglio’s research is broadly focused on asset pricing, which studies how investors perceive and manage risk in financial markets. he focuses on is climate finance, which is the study of how financial markets manage the risks posed by climate change.According to Edieal Pinker, director of studies and assistant dean of the School of Management, Giglio’s research is important because it proves that information on climate change affects financial markets and provides the tools for investors to manage the climate risk.
Pinker added that Giglio’s work on long-term discount rates can potentially guide policy makers in balancing current and future societal needs, when it comes to investments made to address climate change. “Financial markets play several important roles in managing climate risks.” Giglio wrote. “First, they can help reallocate resources from polluting businesses and industries to (more) green businesses…Second, they can help businesses and investors share the risks arising from climate change…that is- i.e. to transfer risk from the most affected to the least affected or most affected capable of bearing those risks. My research has mostly focused on the second role. In an email to Yale News, Pinker pointed out that the award was well-deserved, describing Giglio as “a wonderful, insightful and friendly colleague who makes SOM a better place. Other colleagues shared the same sentiment. Toby Moskowitz, professor of finance at the School of Management, told the News that Giglio is extremely “generous with his time” with his peers and students.
Designing climate policy is difficult because the risks of doing too little, while huge, are unlikely to hit us for a long time. In contrast, the costs of doing anything hit us today. Professor Giglio’s research shows how current market data can make this debate possible. It allows for serious political discussion on topics previously dominated only by rhetoric. Before coming to Yale, Giglio was a professor at the University of Chicago Booth School of Business. Before that, he received his bachelor’s degree in economics from Bocconi University in 2006 and his doctorate in economics from Harvard University in 2011. Asked about Giglio’s success, Kelly Shue, professor of finance at the Yale School of Management, shared a memory of their days as PhD students. “I first met Stefano when we were new students together in Harvard’s economics PhD program,” Shue wrote in an email to the News. “He introduced himself and told me he was stressed about our upcoming exams and then he got the highest mark in our class. Fifteen years later Stefano is still the smartest and hardest working person I’ve ever seen. I know.
What next? In his own words, his next steps would be to continue studying climate finance and explore other areas of asset pricing, such as volatility risk and crash risk. We all know that although there has been an explosion of research in this area in recent years, there are still many aspects of climate risks and their interaction with financial markets that we do not understand. The beauty of economics is that it gives us a lens to understand a very tangible aspect of the world around us: the behavior of people. By trying to use theories and concepts to understand actual observed behavior, one can really get the most out of [economics]. We use a wide range of stock returns to estimate a rich affine model of stock prices, dividends, yields and their dynamics. Using the model, we price the dividend tranches of the overall equity index, as well as any other well-diversified equity portfolio. We do not use any ex-dividend data in the estimation of the model; however, the stock returns implied by the model generated by the model closely match the stock returns of traded dividend futures reported in the literature. Professor Giglio’s model instead proposes to extend data on the term structure of discount rates in four dimensions: (i) over time, going back to the 1970s; (ii) across all maturities, as we are not limited by the maturities of the dividend claims actually traded; and most importantly, (iii) across portfolios, since we generate a term structure for any equity portfolio (eg small stocks or value stocks) and (iv) hedging climate risks.
In addition, his work measures the joint default risk of financial institutions by exploiting counterparty risk information in credit default swaps (CDS) and any new shocks that arise due to climate change events. For example, a CDS contract taken out by a bank to insure against the default of another bank is exposed to the risk of default by both banks. From CDS spreads, we can then learn about the joint default risk of bank pairs. From bond prices, we can learn individual probabilities of default. Since it is not enough to know individual and pairwise probabilities to fully characterize multiple default risk (a platform that now also includes climate change risks), which means deriving the most stringent bounds on the likelihood that many banks, companies, markets, etc. simultaneously fail. Something we have only recently seen happen in Sri Lanka and a phenomenon that we may not be too far off from.
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