In Conversation with Prof Rob Bauer

Dr Tom Gosling interviews Rob Bauer, Professor of Finance at the University of Maastricht on his co-authored paper with Katrin Gödker (Bocconi University), Paul Smeets (University of Amsterdam) and Florian Zimmerman (University of Bonn), 
"Mental Models in Financial Markets: How Do Experts Reason About the Pricing of Climate Risk?"

The key discussion points are:

• Investor beliefs and reasoning are crucial for understanding how risks such as climate risk are priced in markets
• Such beliefs and reasoning cannot be directly observed but can be inferred from surveys build on behavioural economic techniques
• CFA-qualified finance professionals have heterogeneous beliefs about the extent to which climate is correctly priced by markets, with most believing it is under or over incorporated in prices
• Two main “mental models” are exhibited to explain the mis-pricing: market frictions, due to insufficient or inadequate implications on climate risks; and behavioural factors relating to second order beliefs: investors’ beliefs about other investors’ beliefs
• Investors who believe climate change is under-incorporated in prices and who believe that other investors underestimate the effects in prices have higher return expectations for a climate investment index versus the market, and an experience in the survey methodology suggests this is a causal relationship
• Many investors expect the mispricing  to persist for many years or even decades, making it challenging for investors to trade on their views

We hope you enjoy the conversation. For more interviews in this series, visit this page.