Mental Models in Financial Markets: How Do Experts Reason about the Pricing of Climate Risk?

Rob Bauer (), Katrin Gödker (), Paul Smeets () and Florian Zimmermann
Additional contact information
Rob Bauer: Maastricht University
Katrin Gödker: Bocconi University
Paul Smeets: University of Amsterdam

No 17030, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: We investigate financial experts' beliefs about climate risk pricing and analyze how those beliefs influence stock return expectations. In a comprehensive survey, we elicit experts' beliefs using both structured and open-ended questions. We establish that most experts share the view that climate risks are insufficiently reflected in stock prices, yet they hold heterogeneous beliefs about the source and persistence of the mispricing. Through the analysis of open text responses, we delineate distinct mental models used by financial professionals to interpret and predict the asset pricing implications of climate risks. Differences in experts' mental models explain variation in return expectations in the short-term (1-year) and long-term (10-year). Furthermore, we document that experts' political leanings and geography determine the type of mental model they hold. In a last step, we show that one widely held mental model, which is based on second-order beliefs, causally affects experts' return expectations using an information provision experiment.

Keywords: climate finance; climate risk; mental models; 2nd order beliefs (search for similar items in EconPapers)
JEL-codes: D01 G10 G40 (search for similar items in EconPapers)
Pages: 88 pages
Date: 2024-05
New Economics Papers: this item is included in nep-env
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Mental Models in Financial Markets: How Do Experts Reason About the Pricing of Climate Risk? (2024)
Working Paper: Mental Models in Financial Markets: How Do Experts Reason about the Pricing of Climate Risk? (2024)
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