Price of Long-Run Temperature Shifts in Capital Markets

57 Pages Posted: 22 Aug 2016

See all articles by Ravi Bansal

Ravi Bansal

Duke University and NBER

Dana Kiku

University of Illinois at Urbana-Champaign

Marcelo Ochoa

Board of Governors of the Federal Reserve System

Date Written: August 2016

Abstract

We use the forward-looking information from the US and global capital markets to estimate the economic impact of global warming, specifically, long-run temperature shifts. We find that global warming carries a positive risk premium that increases with the level of temperature and that has almost doubled over the last 80 years. Consistent with our model, virtually all US equity portfolios have negative exposure (beta) to long-run temperature fluctuations. The elasticity of equity prices to temperature risks across global markets is significantly negative and has been increasing in magnitude over time along with the rise in temperature. We use our empirical evidence to calibrate a long-run risks model with temperature-induced disasters in distant output growth to quantify the social cost of carbon emissions. The model simultaneously matches the projected temperature path, the observed consumption growth dynamics, discount rates provided by the risk-free rate and equity market returns, and the estimated temperature elasticity of equity prices. We find that the long-run impact of temperature on growth implies a significant social cost of carbon emissions.

Suggested Citation

Bansal, Ravi and Kiku, Dana and Ochoa, Marcelo, Price of Long-Run Temperature Shifts in Capital Markets (August 2016). NBER Working Paper No. w22529. Available at SSRN: https://ssrn.com/abstract=2827447

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Dana Kiku

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

Marcelo Ochoa

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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