Climate risks and market efficiency

By Harrison G. Hong, Frank Weikai Li, Jiangmin Xu. Journal of Econometrics, 2017

712 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Soil Science

View Paper: https://www.semanticscholar.org/paper/a269909089901737a3004870f9affc782ef6b391

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Citations in the corpus

Climate Risk and Capital Structure (2019, neutral): “Drought Severity Index to estimate countries’ vulnerability to droughts, Hong et al. (2019) show that equity markets do not anticipate the effects of predictably worsening droughts on agricultural firms until after they materialize.”
Climate Change and Corporate Cash Holdings: Global Evidence (2020, positive): “and prior to 1985 the climate change was less of an issue, we follow Hong et al. (2019) and restrict”
The impact of climate change on the cost of bank loans (2020, neutral): “Among the natural disasters that might be intensified by climate change, drought is the most devastating for economic activities (Huynh et al. 2020; Hong et al. 2019; Lesk et al. 2016).”
Greening monetary policy (2019, background): “Hong et al. (2019) investigated whether stock markets efficiently price risks caused by climate change.”
Investing for long-term value creation (2019, background): “Hong, Li, and Xu (2016) find that markets that are inexperienced with climate change tend to underreact to risks brought on or exacerbated by climate change.”
Climate Change, Firm Performance, and Investor Surprises (2019, neutral): “Studies have illustrated this relation using financial returns in the food industry [Hong et al., 2019].”
Climate Change News Risk and Corporate Bond Returns (2020, neutral): “This finding is consistent with the idea of stranded assets, where investors divest or avoid these assets altogether because they face high environmental regulatory risk and do not provide investors with hedging capacity (Hong, Li, and Xu (2019) andHong et al. (2020)).”
Green Bond Finance and Certification (2017, background): “Indeed, a number of academic studies have documented a tendency for investors to inadequately price environmental risks (Hong et al (2016) and references therein).”