Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

57 Pages Posted: 25 Jul 2019 Last revised: 21 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 - SC Johnson College of Business

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)

Board of Governors of the Federal Reserve System ( email )

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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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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 - SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

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