Could ‘Carbon Bonds’ Mitigate Global Warming?
According to Bob Litterman, many private investors are nervous about investing heavily in climate solutions, because they lack confidence that such investments will pay off. Governments might promise that fossil fuels and other carbon sources will be very expensive in the future, but they are notorious for saying one thing and then doing another.
In economics, this is a well know problem and is referred to as time inconsistency (Finn Kydland and Edward Prescott won a Nobel Prize for their work on that). When it comes to climate change, investors apparently worry that governments might back away from their commitment to a high carbon price, if there’s a substantial political or indeed economic backlash.
Bob argues that a carbon-linked bond market would turn an empty promise into one that would be costly to break, because if a government didn’t meet its carbon-price target, and didn’t compensate bondholders by paying them more as a result, it would be in default, which is something governments really don’t want.
At this point this is simply an idea. We have therefore invited Bob to convince us that carbon-linked bonds really could mitigate global warming.