The Temperature Effect and Sovereign Bond Returns

Abstract

The relationship between air temperature and sovereign bond returns is founded on competing paradigms: macroeconomic, behavioral, and energy demand-based. Which of these theoretical mechanisms receives support from data? To answer this, we examine four decades of bond data from 31 countries. Generally speaking, daily temperature positively affects government bond returns. A 10°F rise leads to an increase in sovereign bond returns between 0.22 and 0.85 basis points. We also document evidence of asym-metric and nonlinear price responses to both temperature levels and shocks. Our results support the macroeconomic and behavioral paradigms, albeit not the energy demand-based view. Our findings survive a battery of robustness checks.

Keywords: air temperature, sovereign bond returns, international government bond markets, mac-roeconomic channels, behavioral paradigm, energy demand-based view, asset pricing anomalies, risk aversion, seasonal affective disorder

JEL Classification: G10, G12, G14, G15