Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

50 Pages Posted: 4 Dec 2018 Last revised: 1 Oct 2019

See all articles by Mathias S. Kruttli

Mathias S. Kruttli

Board of Governors of the Federal Reserve System; University of Oxford - Oxford-Man Institute of Quantitative Finance

Brigitte Roth Tran

Board of Governors of the Federal Reserve System

Sumudu W. Watugala

Cornell University - Dyson School of Applied Economics and Management

Multiple version iconThere are 3 versions of this paper

Date Written: October 1, 2019

Abstract

We investigate the uncertainty dynamics surrounding extreme weather events through the lens of option and stock markets by identifying market responses to the uncertainty regarding both potential hurricane landfall and subsequent economic impact. Stock options on firms with establishments exposed to the landfall region exhibit large increases in implied volatility of up to 30 percent, reflecting impact uncertainty. Impact uncertainty persists for several months after landfall. Using hurricane forecasts, we show both landfall uncertainty and potential impact uncertainty are reflected in prices before landfall. Our findings are consistent with investors paying attention to hurricanes as they unfold.

Keywords: extreme weather events, uncertainty, implied volatility, stock returns, hurricanes, climate finance

JEL Classification: G12, G14, Q54

Suggested Citation

Kruttli, Mathias S. and Roth Tran, Brigitte and Watugala, Sumudu W., Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics (October 1, 2019). Available at SSRN: https://ssrn.com/abstract=3284517 or http://dx.doi.org/10.2139/ssrn.3284517

Mathias S. Kruttli (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/mathias-s-kruttli.htm

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

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Oxford, Oxfordshire OX2 6ED
United Kingdom

HOME PAGE: http://sites.google.com/site/mathiaskruttli/home

Brigitte Roth Tran

Board of Governors of the Federal Reserve System ( email )

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

Sumudu W. Watugala

Cornell University - Dyson School of Applied Economics and Management ( email )

Ithaca, NY
United States

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