Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics
69 Pages Posted: 11 Sep 2019 Last revised: 28 Jan 2020
Date Written: January 28, 2020
This paper isolates and estimates extreme weather uncertainty and its dynamics. Our framework identifies market responses to the uncertainty regarding both potential hurricane landfall and subsequent economic impact. Stock options of firms with establishments exposed to the landfall region exhibit large increases in implied volatility of up to 30 percent, reflecting impact unncertainty, which persists up to four months after landfall. Using hurricane forecasts, we find both landfall uncertainty and potential impact uncertainty are reflected in option prices before landfall. Our findings show the significant costs to hedging extreme weather uncertainty and have important implications for assessing the economic effects of extreme weather events.
Keywords: extreme weather, uncertainty, implied volatility, hurricanes, climate risks
JEL Classification: G12, G14, Q54
Suggested Citation: Suggested Citation