Extreme Weather Risk and the Cost of Equity
Posted: 18 Nov 2021 Last revised: 3 Feb 2023
Date Written: February 3, 2023
We examine if extreme weather exposure impacts the cost of equity of U.S. firms. Motivated by a consumption-based asset pricing model with heterogeneous agents, we derive two conditions for a meteorological risk premium in the cross-section of stock returns that can be tested em- pirically. We find that – since the mid 1990s – stocks of domestic firms that reacted negatively to severe storm losses outperformed stocks that reacted positively by at least 6.5% p.a. This risk premium can neither be explained by standard asset pricing factors nor firm characteristics. Our results reveal how climate risk may be linked to firm value.
Keywords: Extreme Weather Risk, Climate Risk, Cost of Equity, Empirical Asset Pricing
JEL Classification: C12, G01, G11, G12, G17
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