Adaptation Finance, Real Options, India and Swimming Pools

by Jed Wolf ’13

I have just completed my fourth week of interning at The Energy and Resources Institute (TERI) in New Delhi India. When I arrived at the TERI I was assigned to work in the Climate Change and earth science division, however, I have a growing interest in energy, finance and climate change so in the first few days I spoke with several people in different departments to see with whom and what I wanted work on. I decided to work on a project with Arnab Bose, who holds two masters degrees, one in finance and one in economics and has studied in Amsterdam, Beijing and New York, that focuses on the adaptation finance and real options project.

This project applies methodologies used in finance to climate policy. Options valuation is a financial tool used to hedge against risk when there are uncertainties about future market conditions. A simple example of a financial option (specifically a European call option) is purchasing the right to buy a stock at a price set today, say $100, in one years time. In one year, if the stock price is above the exercise price ($100) then the holder of the option will exercise the option and make profit (market price – $100 – price of the option). However, if the stock price in one year is less than the exercise price the option holder will not exercise the option and simple lose what she paid for the option. In this way the investor does not bear the risk of the stock plummeting but still holds the possibility to profit if it does well. There are a number of different ways to value options (the most widely used in the stock market is called the Black-Scholes method), which are based on a number of different variables including the volatility (variance) of historical stock prices. Options are also used in real life business scenarios such as project planning. These options are known as real options and help managers analyze the value of postponing partial investment until more complete information is available.

Like finance, there are many uncertainties in the conditions of future regional climates and the needs of communities to adapt to these future conditions. Therefore, investing a large sum of capital in one decision that will supposedly reduce the impact of climate disaster in the next 50 years could turn out to be a catastrophe if the investment is put into the wrong project. Therefore, applying adaptation methods that allow for partial initial investment and incremental additional investments can help communities tailor adaptation strategies to the most up to date information.

Adaptation finance can be broken down to the macro and micro level, both of which can use some form of real options valuation to best allocate funds. On the macro level there are a number of different means of obtaining adaptation funds. These are mainly for funds from developed countries to developing countries to be used for climate adaptation (for example, Kyoto protocol Adaptation fund). At present, these funds are based on voluntary actions (for the Adaptation Fund 2% of CDM credits sold and donations) and are neither reliable nor substantial compared to the needs of the developing world. The funds that do exist are supposed to be allocated to the “most vulnerable” communities. However, there is no current standard metric used to identify most vulnerable communities, nor is there a way of comparing the opportunity cost of capital between projects.

On the micro level, once funds are available, fund managers must discern the best projects to fund. There are typically two approaches in doing this; one is relies on planning based on risk probabilities for long-term future events (mostly done by developed nations) and the other is based on present or recent historical conditions to make areas more resistant in the present day and near future (typically exercised by at risk developing nations). We then introduce the concept of resilience centers; regional fast response centers that incorporate probabilistic planning with present and historic data to implement site affordable specific adaptation strategies.

This is just a short overview of the work that I have been doing. We just submitted a paper called The Future of Adaptation Finance: methods and perspectives. Which I will share with BCEP once it is published.

In terms of my day-to-day work life, I am unsupervised; sit in the library and research. If I have a question or want to meet with Mr. Bose (which happens about three times a week) I send him an email and we arrange a time to meet. Some days I work from home. The building that I work in (the India Habitat Center) is home to many other international organizations and there are often conferences and events that I can attend if I want to. I attended one on the transportation plan for 2021 in Delhi and another on women’s rights and the need for toilets in rural areas (at both of which I got a free feast of Indian delights). There is also an exclusive gym and pool that I have access to between 1 and 3pm that I sometimes use. My routine consists of ordering pizza, swimming, eating under a shaded canopy by the pool (which is on the top floor of the building) and then sitting in the steam room. All in all I am thoroughly enjoying myself, I am mentally stimulated with cutting edge theories about work that is relevant to my career and I am able to work in my own style.

To read about TERI visit teriin.org.

Feel free to email me with any questions.
Namaste,

Jed Wolf

jw113@bard.edu

For more info about Me in India check out my blog: jedlobo.tumblr.com

About Jed Wolf