Ron Dembo is a modern-day Renaissance man, with several advanced STEM degrees, three published books, successful startups and a handful of patents in computational finance under his belt. Now, the world-renowned expert on risk and climate change has a new venture to harness artificial intelligence to measure the financial impacts of climate change. He spoke with Global Finance about how climate change requires new approaches to risk analysis.
Global Finance: Why did you found your latest venture, Riskthinking.ai?
Ron Dembo: Because the impact of global risks such as the climate emergency are being miscalculated in many domains, including the financial sector. Put succinctly, climate risk is not properly priced into our markets.
GF: What mistakes in risk management related to the environment most concern you?
Dembo: Historically, the risk management function has underestimated risk by a wide margin. For me, and for our board members and advisers, the issue is this: Historical data don’t make it possible to forecast the nonlinear risk of climate change, and makes potential risk underestimations materially relevant. The measures we’ve seen have relied too heavily on the past as a predictor of the future. Consensus measures that come from science emphasize likely events and not the extremes in the tail. Risk measurement for climate change is about estimating the extremes, or tail risk.
GF: How does risk thinking help decision-makers improve their approach to water issues?
Dembo: At our company, we define “risk thinking” as a mindset that comprehends plausible futures through the lens of scenario-generation. Risk thinking—in contrast to conventional forecasting—generates a set of scenarios that spans the best and worst cases. And it takes a close look at a number of possible actions, including hedging the “bad” scenarios while orienting to the best ones. Related to the global water crisis, riskthinking.AI generates a forward-looking understanding of water risk using machine learning to estimate the future possibilities for each and every risk factor affecting water.
GF: How can your approach to risk thinking revolutionize finance for the 21st century?
Dembo: Ultimately, it is the unique ability to generate scenarios using a mathematically sound algorithm that allows us to achieve consistency across companies and market sectors. Consistency allows us to properly price risk and to compare the effects of climate change on companies in a way that allows investors to choose rationally between stocks.
Risk thinking is particularly suited to a very uncertain world where past and existing experience is only a partial aid to measuring future risk. Our methodology allows for combining risk factors that may be financial, nonfinancial, climatic or political into scenarios generated by an algorithm that guarantees that we capture the very best and worst scenarios possible.