Abstract
We study how global equity markets price the physical climate risk associated with tropical cyclones. To assess firms’ exposure to this risk, we use a bottom-up, forward-looking measure of firms’ expected losses to their geolocalized physical assets based on simulated cyclone tracks under different climate scenarios (RCP 2.6, 4.5, and 6.0). Throughout the sample period 2016-2022, we find no significant premium for tropical cyclone related risks. But realized return may be affected by shifts in investors’ concerns about physical risks. To measure these concerns, we use the search volume index (SVI) from Google Trends as the primary indicator, along with the global monthly occurrence of tropical cyclones for additional validation. We find that a one standard deviation higher exposure under RCP 4.5 is associated with a 1.05% higher annual returns during periods of low cyclone concern. However, during periods of heightened cyclone concern, a one standard deviation higher exposure is associated with a 2.31% lower annualized return. Overall, our results suggest that global equity markets have begun to price in the physical climate risk associated with tropical cyclones. However, during periods of increased cyclone activity, investor concerns may reduce demand for stocks that are more exposed to this risk, causing their prices to fall.
Keywords: Physical climate risks, stock returns, geolocalized physical assets, global ownership data, probabilistic disaster risk, climate risk pricing
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