Creating a financial model to value water risk for businesses

Aug 28, 2014 by Greta Guest

With water risk rising in some companies and basins as a more urgent problem than climate change, University of Michigan researchers have worked out a way to measure how it affects stock volatility.

Peter Adriaens, an entrepreneurship professor at the Zell Lurie Institute at the Ross School of Business, along with current and former students Kristine Sun and Ran Gao, wanted to know how the financial and operational risks can be quantified when a business faces water access constraints.

"My ultimate objective is can we extract market signals out of stock volatility behavior that tells companies how financially exposed they are," Adriaens said. "What we wanted to measure is what is the opportunity cost to a company of not having water in a bucket. How is this going to impact a company?"

A series of stories in the Financial Times last month estimated that $84 billion was spent in the past three years to conserve, manage or obtain water. And Moody's indicates that water scarcity has credit-negative implications in the mining industry. Voluntary water risk disclosures are on the rise across all industry sectors. Increasingly, methodologies are being developed to capture operational cost or policy risk to understand the magnitude of corporate water exposure.

Adriaens' research tests the hypothesis that water risk impacts revenue and the cost of doing business, asset risk and by inference, stock volatility, unless the company manages its risk appropriately. He related stock volatility metrics and water risk exposures of four electric utilities in 2007-08, a two-year period that captured multiple drought events, commodity (coal) price fluctuations and systemic risk in the financial markets.

And Adriaens asked the question whether these asset risk pricing and stock sensitivity metrics can be used to make portfolio allocation decisions. The opportunity then arises to extract market signals for corporate . The premise is that business water risk has a measurable and material impact on equity and portfolio volatility.

"Business water risk is not about price, but about opportunity cost. It's about businesses losing economic output," Adriaens said. "The loss of economic output is what is being valued in the market...opportunity costs and the fear of stranded assets."

Explore further: Shifting innovation in reverse could solve urban transit issues

add to favorites email to friend print save as pdf

Related Stories

Powerful tool helps explain water risk

Mar 24, 2014

Water crises ranked third among 10 global risks of highest concern in 2014, according to the World Economic Forum's annual Global Risks Perception Survey. With water risk on the agenda of business and investors ...

Ordered fear plays a strong role in market chaos

Jun 08, 2011

When the current financial crisis hit, the failure of traditional economic doctrines to provide any sort of early warning shocked not only financial experts worldwide, but also governments and the general public, and we all ...

Recommended for you

Insider trading study shows stronger enforcement

23 hours ago

The first major study of the enforcement of Australia's insider trading laws has shown the number of insider trading cases brought by the Australian Securities and Investment Commission (ASIC) is increasing, ...

The unexpected benefits of adjustable rate mortgages

Oct 22, 2014

Using loan level data matched to consumer credit records, researchers have been able to determine that a reduction in mortgage payments of as little as $150 a month spurred a reduction in mortgage defaults and an increase ...

Migrant employment on the rise

Oct 20, 2014

Skilled migrants are enjoying better jobs and higher levels of employment thanks to a shift in policy, according to a new study by the Melbourne Institute of Applied Economic and Social Research at the University ...

User comments : 0