Blame it on the weather: Market implied weather volatility and firm performance

Abstract

We introduce a novel measure of weather risk implied from weather options' contracts. WIVOL captures risks of future temperature oscillations, increasing with climate uncertainty about physical events and regulatory policies. We find that idiosyncratic weather risk shocks are priced, worsen firms' operating performance and increase the uncertainty about firms' fundamentals, suggesting that firms, on average, do not fully hedge exposures to weather risk. We estimate returns' exposure to WIVOL innovations and show that more negatively exposed firms are valued at a discount, with investors demanding higher compensations to hold these stocks. Firms' exposure to local but not foreign WIVOL predicts returns, which confirms the geographic nature of weather risk.

Keywords: JEL Classification: G11, G12, Q54 climate finance, option prices, stock returns, weather risk

JEL Classification: G11, G12, Q54