Extreme high surface temperature events and equity-related physical climate risk

Abstract

By matching the timing and geography of extreme high surface temperature (EHST) events in the United States to the location of firms' headquarters, we are able to measure the equity market’s response to an exogenous shock deemed by climate scientists to relate proximately causally to equity-related physical climate risk. Measured as the cumulative excess return over EHST day 0 (the initial shock) to EHST day 20, we find that the equity market responds negatively to EHST events (−0.42%), and more negatively to costlier events (−1.38%) and those of longer duration (−0.68%). Firms in counties in the South and Southeast climate regions, the month of July, and the most recent decade of the study period (2008–2017) experience the most negative cumulative excess returns in response to EHST events. In addition, consistent with equity investors' recognition of physical climate risk, equity price volatility increases over EHST days 0–20, rising even more for costly and long-duration events. Our findings imply that the equity market recognizes but underprices physical climate risk, consistent with forming biased expectations of future equity returns.