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Climate Risks and Market Efficiency

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  • Harrison Hong
  • Frank Weikai Li
  • Jiangmin Xu

Abstract

We investigate whether stock markets efficiently price risks brought on or exacerbated by climate change. We focus on drought, the most damaging natural disaster for crops and food-company cash flows. We show that prolonged drought in a country, measured by the Palmer Drought Severity Index (PDSI) from climate studies, forecasts both declines in profitability ratios and poor stock returns for food companies in that country. A portfolio short food stocks of countries in drought and long those of countries not in drought generates a 9.2% annualized return from 1985 to 2015. This excess predictability is larger in countries having little history of droughts prior to the 1980s. Our findings support regulatory concerns of markets inexperienced with climate change underreacting to such risks.

Suggested Citation

  • Harrison Hong & Frank Weikai Li & Jiangmin Xu, 2016. "Climate Risks and Market Efficiency," NBER Working Papers 22890, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:22890
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    Cited by:

    1. Stefano Giglio & Bryan Kelly & Johannes Stroebel, 2021. "Climate Finance," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 15-36, November.
    2. Finnegan, Stephen & Sharples, Steve & Johnston, Tom & Fulton, Matt, 2018. "The carbon impact of a UK safari park – Application of the GHG protocol using measured energy data," Energy, Elsevier, vol. 153(C), pages 256-264.
    3. Torsten Ehlers & Frank Packer, 2017. "Green bond finance and certification," BIS Quarterly Review, Bank for International Settlements, September.
    4. Gallic, Ewen & Vermandel, Gauthier, 2017. "Weather Shocks, Climate Change and Business Cycles," MPRA Paper 81230, University Library of Munich, Germany.
    5. Mukanjari, Samson & Sterner, Thomas, 2018. "Do Markets Trump Politics? Evidence from Fossil Market Reactions to the Paris Agreement and the U.S. Election," Working Papers in Economics 728, University of Gothenburg, Department of Economics.
    6. Davide Benedetti & Enrico Biffis & Fotis Chatzimichalakis & Luciano Lilloy Fedele & Ian Simm, 2021. "Climate change investment risk: optimal portfolio construction ahead of the transition to a lower-carbon economy," Annals of Operations Research, Springer, vol. 299(1), pages 847-871, April.
    7. Liu, Chao & Akintayo, Adedotun & Jiang, Zhanhong & Henze, Gregor P. & Sarkar, Soumik, 2018. "Multivariate exploration of non-intrusive load monitoring via spatiotemporal pattern network," Applied Energy, Elsevier, vol. 211(C), pages 1106-1122.
    8. Dirk Schoenmaker & Willem Schramade, 2019. "Investing for long-term value creation," Journal of Sustainable Finance & Investment, Taylor & Francis Journals, vol. 9(4), pages 356-377, October.
    9. Martijn Boermans & Rients Galema, 2017. "Pension funds carbon footprint and investment trade-offs," DNB Working Papers 554, Netherlands Central Bank, Research Department.
    10. Deng, Gary & Newton, Peter, 2017. "Assessing the impact of solar PV on domestic electricity consumption: Exploring the prospect of rebound effects," Energy Policy, Elsevier, vol. 110(C), pages 313-324.
    11. Lööf, Hans & Martinsson, Gustav & Mohammadi, Ali, 2017. "Finance and Innovative Investment in Environmental Technology: The Case of Sweden," Working Paper Series in Economics and Institutions of Innovation 445, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    12. Sam Fankhauser, 2017. "Adaptation to Climate Change," Annual Review of Resource Economics, Annual Reviews, vol. 9(1), pages 209-230, October.
    13. McKellar, Jennifer M. & Sleep, Sylvia & Bergerson, Joule A. & MacLean, Heather L., 2017. "Expectations and drivers of future greenhouse gas emissions from Canada's oil sands: An expert elicitation," Energy Policy, Elsevier, vol. 100(C), pages 162-169.
    14. Boermans, Martijn A. & Galema, Rients, 2019. "Are pension funds actively decarbonizing their portfolios?," Ecological Economics, Elsevier, vol. 161(C), pages 50-60.
    15. Chen, Sicen & Liu, Siyi & Zhang, Junsheng & Zhang, Pengdong, 2023. "The effect of extreme rainfall on corporate financing policies," Journal of Economic Behavior & Organization, Elsevier, vol. 216(C), pages 670-685.

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    More about this item

    JEL classification:

    • G0 - Financial Economics - - General
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • Q0 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General
    • Q5 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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