Abstract:
In this study, we contribute to the rapidly growing climate-finance literature by shedding
light on the question of whether climate risks have predictive value for stock market returns. We
measure climate risks in terms of both the change in the northern hemisphere temperature anomaly
and its volatility and the change in the global temperature anomaly and its volatility. We study
monthly data for eight advanced countries (Canada, France, Germany, Italy, Japan, Switzerland,
the United Kingdom (UK), and the United States (US)). Our sample period runs from 1916 to 2021.
We control for cross-market spillovers of stock market returns and volatility as well as other risks
including oil-price returns and volatility, geopolitical risks, and the gold-to-silver price ratio as a
measure of investor risk aversion. Given this large array of control variables, we apply the Lasso
estimator to trace out the incremental predictive value of climate risks for subsequent stock market
returns. We find that climate risks do not have systematic predictive value for subsequent stock
market returns. We then extend our analysis in two ways. First, we show that climate risks have
short-term out-of-sample predictive value for the connectedness of stock market returns. Second,
we show that climate risks have predictive power for stock market returns when we study monthly
historical UK data for the sample period from 1772 to 2021.
