Volatile temperatures and their effects on equity returns and firm performance

This paper examines two statistics that can serve as metrics to evaluate the impact of climate change-induced temperature changes on firms and investors: changes in the mean and in the standard deviation of temperature anomalies.

The authors show that temperature variability rather than mean temperature has a material financial impact, demonstrating this effect on US firms’ stock returns and operating performance: quarterly firm return-on-asset significantly declines with greater temperature variability, reflecting fundamental changes in firm value. These outcomes are driven by reductions in consumer demand and labour productivity coupled with changes in media and investor attention.

The authors provide a geographically scalable statistical framework for assessing the quantitative effects of climate-related physical risks such as shifts in temperature distribution, offering a metric for improving the disclosure of material climate risks and helping firms, investors and government agencies to address the climate risk information gap.

Key points for decision-makers

• Regulations for firms regarding the disclosure of financial risk from climate change are unstandardised and may not be based on financial materiality.  
• The authors have developed a robust way of quantifying the financial material risk of changing temperature distributions to firm performance. Tracking changes in the variability of temperature anomalies across geographical and temporal dimensions enables quantitative, standardised and comparable disclosures of material temperature risks, which are causally linked to financial, behavioural and economic outcomes.
• They implement a geographic long–short portfolio strategy, using Russell 3,000 firms (the largest 3,000 US companies), to examine the impact of state-level exposure to each temperature metric – changes in mean temperature and changes in temperature variability – on returns from 2005 to 2019.
• They conclude that equities are responsive to shifts in temperature variability, but show no reaction to changes in the mean temperature.
• Temperature variability is given exposure by the media; affects investor beliefs and behaviour; reduces number of hours worked (especially in sectors including construction, durables and hospitality); and can reduce consumption: all these factors affect firm value.
• The authors show how firms can use the temperature variability metric to report their exposure to future temperature risk, informing financial markets about their vulnerability to climate-related temperature shocks in the future; and how it can help investors evaluate the exposure of companies within their portfolios over a relevant future time horizon and adjust their allocation to minimise portfolio exposure.