Temperature Sensitivity, Mispricing, and Predictable Returns

100 Pages Posted: 26 Feb 2019 Last revised: 12 Apr 2024

See all articles by Carina Cuculiza

Carina Cuculiza

Oklahoma State University - Stillwater - Spears School of Business

Alok Kumar

University of Miami - Miami Herbert Business School

Wei Xin

University of Exeter Business School

Chendi Zhang

University of Exeter Business School

Date Written: April 11, 2024

Abstract

Using a time-varying measure of firm-level temperature sensitivity, we examine the relation between temperature changes and firm performance. We find that firms with a higher temperature sensitivity have lower future profitability and riskier corporate policies. These firms are also overpriced as they earn lower average future returns. Market participants potentially contribute to the mispricing. Nonlocal institutional investors allocate higher portfolio weights to high temperature sensitivity firms and sell-side equity analysts issue less accurate forecasts for these firms. Together, these results suggest that financial markets under-react to firm-specific information about temperature changes, which generates predictable patterns in returns. A trading strategy that exploits this mispricing generates an annualized risk-adjusted return of over 4% during the 1968-2020 period.

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

JEL Classification: G12, G14

Suggested Citation

Cuculiza, Carina and Kumar, Alok and Xin, Wei and Zhang, Chendi, Temperature Sensitivity, Mispricing, and Predictable Returns (April 11, 2024). Available at SSRN: https://ssrn.com/abstract=3331872 or http://dx.doi.org/10.2139/ssrn.3331872

Carina Cuculiza

Oklahoma State University - Stillwater - Spears School of Business ( email )

201 Business
Stillwater, OK 74078-0555
United States

Alok Kumar (Contact Author)

University of Miami - Miami Herbert Business School ( email )

517B Jenkins Building
Department of Finance
Coral Gables, FL 33124-6552
United States
305-284-1882 (Phone)

HOME PAGE: http://sites.google.com/view/alokmiami/home

Wei Xin

University of Exeter Business School ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

Chendi Zhang

University of Exeter Business School ( email )

Streatham Court
Xfi Building, Rennes Dr.
Exeter, EX4 4JH
United Kingdom

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