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Temperature, Aggregate Risk, and Expected Returns (2010)
| Citations: | 3 - 1 self |
BibTeX
@MISC{Bansal10temperature,aggregate,
author = {Ravi Bansal and Marcelo Ochoa},
title = {Temperature, Aggregate Risk, and Expected Returns},
year = {2010}
}
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Abstract
Inthispaperweshowthat temperatureisanaggregate riskfactor that adversely affects economic growth. Our argument is based on evidence from global capital markets which shows that the covariance between country equity returns and temperature (i.e., temperature betas) contains sharp information about the cross-country risk premium; countries closer to the Equator carry a positive temperature risk premium which decreases as one moves farther away from the Equator. The differences in temperature betas mirror exposures to aggregate growth rate risk, which we show is negatively impacted by temperature shocks. That is, portfolios with larger exposure to risk from aggregate growth also have larger temperature betas; hence, a larger risk premium. We further show that increases in global temperature have a negative impact on economic growth in countries closer to the Equator, while its impact is negligible in countries at high latitudes. Consistent with this evidence, we show that there is a parallel between a country’s distance to the Equator and the economy’s dependence on climate sensitive sectors; in countries closer to the Equator industries with a high exposure to temperature are more prevalent. We provide a Long-Run Risks based model that quantitatively accounts for cross-sectional differences in temperature betas, its link to expected returns, and the connection between aggregate growth and temperature risks.
Keyphrases
temperature beta aggregate risk expected return economic growth aggregate growth growth rate risk temperature risk country equity return temperature shock sharp information climate sensitive sector high exposure risk premium cross-country risk premium negative impact economy dependence global capital market inthispaperweshowthat temperatureisanaggregate riskfactor temperature beta mirror cross-sectional difference high latitude equator industry global temperature positive temperature risk premium long-run risk
