Volatility and Risk Institute

OUR MISSION

The Volatility and Risk Institute is an interdisciplinary center for research and analysis of financial and nonfinancial risks. It serves as a designated hub to support risk-related research and collaboration among scholars, practitioners, and policymakers. It supports, promotes, and facilitates risk analysis, assessment, and measurement, and creates a bridge between faculty research and a specialized group of practitioners and market participants on the cutting-edge of real-world risk issues. To assess and analyze these risks, we are employing new data and analytical tools including those from data science and a wide range of machine learning technologies. Our Faculty Board is composed of members from the Tandon School of Engineering, the Courant Institute of Mathematical Sciences, the Wilf Family Department of Politics in the Faculty of Arts & Science, the Wagner Graduate School of Public Service, the School of Global Public Health, the Law School, and the Stern School of Business. Our focus is on newly emerging forms of risk including climate risk, geopolitical risk, cyber risk, more recently pandemic risk, as well as new topics in financial risk.

LETTER FROM OUR DIRECTORS

Dear Supporters of the Volatility and Risk Institute:

When we wrote to you six months ago, we were all still facing the consequences of the global pandemic and attempting to understand its implications for the future. Then and now, a significant share of our work and our time in the classroom has focused -- and continues to focus -- on the financial and economic consequences of the pandemic; on its implications for business models, including of our University; and on the lessons from it for our work.

But we also said then that “we haven’t neglected other aspects of risk; if anything, the pandemic has thrown them into even sharper relief.” Indeed, the focus of our annual conference and on climate-related risks and opportunities, echoing the focus of the new administration in the White House, underscores that point. If there was ever a time to focus on research on climate-related risks, this is it.

Once again, in that context, we want to update you on what we at the VRI have learned, what we have been doing, and where we are headed.

First, developing tools to assess and respond to climate risk continues to be a focus of our research. With the tremendous interest in ESG and sustainable investing by institutional and individual investors, the natural approaches to portfolio selection have not come to any consensus. That partly reflects concerns about greenwashing and about the noise and even more distressing the enormous gaps in ESG data. Our colleagues and we believe that the solution lies in regulatory disclosure requirements to level the playing field, as discussed by our colleagues at the Institute for Policy Integrity in their recent paper and as proposed by the SEC.

In our research we examine the performance of a wide range of publicly-available climate investments. Some of these are diversified portfolios with brown companies deleted and others are select sectors of the economy that are climate leaders. Some are designed to be hedge portfolios for climate risk as we wrote in our RFS paper and others are focused on companies with transition plans. We use statistical analysis to design portfolios of these funds that are most correlated with news about climate change and which turn out to have high alphas over a long period of time. As the composition of this Factor Mimicking Portfolio changes, we can see the changes in which are the most successful ESG portfolios. Several versions of these FMP portfolios will soon be included on VLAB. As many such tests are developed, we envision a climate risk test kit to determine the effectiveness of an investment portfolio in hedging climate risk. This is work in collaboration with Bryan Kelly of Yale.

In related work we use these portfolios and a stranded asset portfolio to generate a market based stress test for financial institutions. We ask, how much the stock would fall, if this climate factor would dramatically decline. This should reflect the materiality of the climate risk to which the bank is exposed.  This stress could lead one or many banks to become undercapitalized as a result of climate deterioration. Regulation of financials is focused on such events as causes of financial crises that can have major macroeconomic impacts. We developed this methodology to measure systemic risk using SRISK and now we are extending it to calculate climate risk or CRISK.

Second, we have discussed creating a “fifth pillar” of risk: Pandemic Risk. We continue to think that we have successfully woven pandemic risk into many aspects of our work; indeed, our studies of the impact of COVID-19 pervade nearly everything we do. It extends to the classroom, where courses explore the vulnerabilities in health care, in businesses, in the economy and in the financial system exposed by the pandemic shock. We and our students have analyzed the policy responses to the pandemic, and have assessed what worked and why. Those courses are now focused on the changes in business models, supply chains, inflation dynamics and financial-market behavior that might persist as pandemic risks dissipate. Faculty research, for example, is focused on the acceleration to technology-enabled platform business models to those based on institutions. There is clearly more work to do in this area.

You will also find new research in geopolitical risk, financial risk and cyber risk on the website. Here too, our work is evident in the classroom, with courses on risk management in the curriculums for undergraduate, MBA, EMBA and Masters in Risk Management programs.

We plan to continue to build on these strands of research and teaching. 

We greatly appreciate your sustaining interest and support, and we look forward to working together with you to deepen our understanding of the challenges presented by these times.

Best Regards,

Robert F. Engle and Richard Berner