- Joined
- 11/10/20
- Messages
- 25
- Points
- 23
Various versions of sustainability-linked products have been around for several years.
For example, lender Alice lends money to borrower Bob, and Bob repays the loan with interest. If Bob's ESG rating goes up, then Alice pays a bonus to Bob. Optionally, if Bob's ESG rating fails to go up, then Alice pays the same bonus to some charity, rather than keep it. Conversly, if Bob's ESG rating goes down, then Bob pays a "malus" to Alice or to a charity. Other than the optional role of a 3rd party charity, these new products are somewhat similar to a loan whose interest rate goes up or down in case of borrower upgrade/downgrade by credit rating agencies, which have been around for a while. A recent ISDA survey describes many versions of sustainability-linked products, almost all of which are just minor variations on this theme.
What models do people use to price and hedge these exposures?
For example, lender Alice lends money to borrower Bob, and Bob repays the loan with interest. If Bob's ESG rating goes up, then Alice pays a bonus to Bob. Optionally, if Bob's ESG rating fails to go up, then Alice pays the same bonus to some charity, rather than keep it. Conversly, if Bob's ESG rating goes down, then Bob pays a "malus" to Alice or to a charity. Other than the optional role of a 3rd party charity, these new products are somewhat similar to a loan whose interest rate goes up or down in case of borrower upgrade/downgrade by credit rating agencies, which have been around for a while. A recent ISDA survey describes many versions of sustainability-linked products, almost all of which are just minor variations on this theme.
What models do people use to price and hedge these exposures?