Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics
55 Pages Posted: 4 Dec 2018 Last revised: 8 Jun 2019
Date Written: May 31, 2019
We investigate the uncertainty dynamics surrounding extreme weather events through the lens of option and stock markets by identifying market responses to both the uncertainty regarding potential hurricane landfall and subsequent economic impact. Stock options on firms with establishments exposed to the landfall region exhibit increases in implied volatility of 5-10 percent, reflecting impact uncertainty. Using hurricane forecasts, we show that landfall uncertainty and potential impact uncertainty are reflected in prices before landfall. We find no evidence that markets incorporate better hurricane forecasts than those from NOAA. Improvements to hurricane forecasts could have economically significant effects in financial markets.
Keywords: extreme weather events, uncertainty, implied volatility, stock returns, hurricanes, climate finance
JEL Classification: G12, G14, Q54
Suggested Citation: Suggested Citation