Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

57 Pages Posted: 25 Jul 2019 Last revised: 1 Jul 2021

See all articles by Mathias S. Kruttli

Mathias S. Kruttli

Kelley Business School - Indiana University

Brigitte Roth Tran

Federal Reserve Bank of San Francisco

Sumudu W. Watugala

Indiana University - Kelley School of Business - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: July, 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 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.

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 (July, 2019). FEDS Working Paper No. 2019-54, Available at SSRN: https://ssrn.com/abstract=3423254 or http://dx.doi.org/10.17016/FEDS.2019.054

Mathias S. Kruttli (Contact Author)

Kelley Business School - Indiana University ( email )

Bloomington, IN 47405
United States

Brigitte Roth Tran

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Sumudu W. Watugala

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

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