Climate Sensitivity, Mispricing, and Predictable Returns

Abstract

We examine the relation between climate change and firm performance. Using a novel measure of firm-level temperature sensitivity, we show that stocks with higher temperature sensitivity are overpriced. They have lower future profitability, riskier corporate policies, and lower future returns. Both institutional investors and sell-side equity analysts contribute to the mispricing. Collectively, these results suggest that financial markets under-react to firm-specific information about climate change, which generates predictable patterns in returns. During the 1968-2020 sample period, a trading strategy that exploits this information generates an annualized risk-adjusted return of over 4%.

Keywords: Climate sensitivity, return predictability, mispricing, market under-reaction, institutional investors, sell-side analysts.

JEL Classification: G12, G14