Climate Risks and Market Efficiency

Harrison Hong, Frank Weikai Li and Jiangmin Xu

No 22890, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: G0 G02 G12 Q0 Q5 Q54 (search for similar items in EconPapers)
Date: 2016-12
New Economics Papers: this item is included in nep-agr and nep-env
Note: AP
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Citations: View citations in EconPapers (16)

Published as Harrison Hong & Frank Weikai Li & Jiangmin Xu, 2018. "Climate risks and market efficiency," Journal of Econometrics, .

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