Climate Change Exposure and Stock Return Predictability

Abstract

This paper finds evidence that stock returns vary with the climate change exposure of firms in a predictable manner. Using the Palmer Drought Severity Index, we construct firm-level climate change exposure and find that firms with high climate change exposure experience lower future profitability. We show that stock prices do not promptly incorporate such climate change information, and these firms with high climate change exposures are subject to subsequent lower stock returns. A long-short trading strategy based on this effect produces significant alphas of around 0.7% per month. Additionally, we find this return predictability is more pronounced under acute climate change conditions, and is robust to industry or macroeconomic factors.

Keywords: Climate Change, Investor Attention, Return Predictability

JEL Classification: G10, G11, G12