Bridging Physical and Financial Business Water Risk: Watervar and Waterbeta Metrics for Equity and Portfolio Risk Assessment

28 Pages Posted: 3 Jun 2014

See all articles by Peter Adriaens

Peter Adriaens

The Stephen M. Ross School of Business at the University of Michigan

Kristine Sun

University of Michigan at Ann Arbor - Department of Mathematics

Ran Gao

University of Michigan at Ann Arbor - Department of Civil and Environmental Engineering

Date Written: May 1, 2014

Abstract

The impact of water as a constrained resource for business operations is becoming part of the investor discourse on equity water risk. A key challenge is the absence of metrics that relate physical risk to financial risk, either at the company or at the portfolio level, resulting in the lack of asset risk pricing. Our research tests the hypothesis that water risk impacts revenue and the cost of doing business and, by inference stock volatility, unless the company manages its risk appropriately. We related stock volatility metrics and water risk exposures of four electric utilities during a two-year period (2007-2008) that captured multiple drought events, commodity (coal) price fluctuations, and systemic risk in the financial markets. Using waterBeta and waterVaR metrics, the impact of water risk on stock volatility (VaR) was highly dependent on the value chain position of the firm, the capital efficiency of water, and stock elasticity. WaterVaR values range from $5M for the Southern Company to $167M for AES. The use of financial risk metrics for water can improve decisions for asset allocation to reduce water risk exposure in portfolios, including stranded assets.

Keywords: water, equity volatility, portfolio risk

Suggested Citation

Adriaens, Peter and Sun, Kristine and Gao, Ran, Bridging Physical and Financial Business Water Risk: Watervar and Waterbeta Metrics for Equity and Portfolio Risk Assessment (May 1, 2014). Ross School of Business Paper No. 1237. Available at SSRN: https://ssrn.com/abstract=2445580 or http://dx.doi.org/10.2139/ssrn.2445580

Peter Adriaens (Contact Author)

The Stephen M. Ross School of Business at the University of Michigan ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Kristine Sun

University of Michigan at Ann Arbor - Department of Mathematics ( email )

2074 East Hall
530 Church Street
Ann Arbor, MI 48109-1043
United States

Ran Gao

University of Michigan at Ann Arbor - Department of Civil and Environmental Engineering ( email )

2350 Hayward Street
2340 GG Brown Building
Ann Arbor, MI 48109-2125
United States

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