Pricing Physical Climate Risk in the Cross-Section of Returns

Abstract

Using location-specific climate exposure measures, I test for the existence of physical climate risk premia. Hurricane risk commands a positive risk premium whilst heat stress commands a negative risk premium. Both exposure to sea-level rise and exposure to extreme rainfall command no risk premium. The priced portion of physical climate risk is only between 8% - 38% of its total variance. The unpriced portion co-varies with fundamental risks in the economy, suggestive of agents struggling to price a material risk, and the unpriced portion can be explained by industry returns and the realisation of severe weather events.

Keywords: Physical Climate Risk, Risk Premia, Asset Pricing

JEL Classification: G12, G14, Q51, Q54