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What do financial markets reveal about global warming? Working paper series--09-13

Du, Ding and Balvers, Ronald and Zhao, Xiaobing (2009) What do financial markets reveal about global warming? Working paper series--09-13. Working Paper. NAU W.A. Franke College of Business.


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Global warming and its importance are controversial. While a variety of estimates exists of the likelihood of global warming and its economic cost, financial market information can provide an objective assessment of expected losses due to global warming. We consider a Merton-type asset pricing model in which asset prices are affected by the changes in investment opportunities caused by global warming. In this setting, global warming would imply a negative risk premium, with most assets loading negatively on the global warming factor, and financial assets in sectors that are more sensitive to global warming exhibiting stronger negative loadings. Utilizing a variant of Campbell and Diebold's (2005) weather forecasting model in conjunction with Lamont's (2001) and Vassalou's (2003) approach for extracting financial market "news", we empirically uncover the global warming factor. We find that the risk premium is indeed significantly negative and becoming more so over time, that loadings for most assets are negative, and that asset portfolios in industries considered to be more vulnerable to global warming (see IPCC, 2007, and Quiggin and Horowitz, 2003) have significantly stronger negative loadings on the global warming factor. We estimate that required returns on average are 0.11 percentage points higher due to the global warming factor, translating to a present value loss of 4.18 percent of wealth. The industry loadings appear to be unrelated to potential vulnerability to emissions regulation. Rather, the loss in wealth represents a general cost from increased systematic risk due to uncertainty in the extent and impact of warming and the increased incidence of extreme weather events, thus complementing existing estimates of the cost of global warming.

Item Type: Monograph (Working Paper)
Publisher’s Statement: Copyright, where appropriate, is held by the author.
ID number or DOI: 09-13
Keywords: Working paper, global warming, economic costs, asset pricing model, risk premiums
Subjects: G Geography. Anthropology. Recreation > GF Human ecology. Anthropogeography
H Social Sciences > HG Finance
NAU Depositing Author Academic Status: Faculty/Staff
Department/Unit: The W.A. Franke College of Business
Date Deposited: 17 Oct 2015 21:20
URI: http://openknowledge.nau.edu/id/eprint/1506

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