Climate Risks and Market Efficiency

79 Pages Posted: 5 Dec 2016

See all articles by Harrison G. Hong

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business

Jiangmin Xu

Peking University - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: December 2016

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

Hong, Harrison G. and Li, Frank Weikai and Xu, Jiangmin, Climate Risks and Market Efficiency (December 2016). NBER Working Paper No. w22890. Available at SSRN: https://ssrn.com/abstract=2880328

Harrison G. Hong (Contact Author)

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

Jiangmin Xu

Peking University - Department of Finance ( email )

5 Yiheyuan Road
Beijing 100871
China

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