Do Fund Managers Misestimate Climatic Disaster Risk

Abstract

We examine whether professional money managers overreact to large climatic disasters. We find that managers within a major disaster region underweight disaster zone stocks to a much greater degree than distant managers and that this aversion to disaster zone stocks is related to a salience bias that decreases over time and distance from the disaster, rather than to superior information possessed by close managers. This overreaction can be costly to fund investors for some especially salient disasters like hurricanes and tornadoes: a long-short strategy that exploits the overreaction generates a significant DGTW-adjusted return over the following 2 years.

Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

“…The question on how accurately investors price climatic event has recently received considerable attention in policy discussions, because inefficient pricing of extreme weather events is a potential financial stability concern (see Carney (2015)). Other papers analyze how efficiently markets price physical climate risks by looking at food company stock returns (Hong, Li, and Xu (2019)) and mutual fund performance (Alok, Kumar, and Wermers (2020)). 25,26 Our analysis sheds light on the accuracy of investors' volatility expectations, which is instrumental for the hedging of climate risks.…”

“…This analysis contributes to the discussion on whether markets efficiently price climatic risks. Our analysis focused on volatility is distinct from recent work focused on returns that analyze if stock investors efficiently price exposure to extreme weather events, which find evidence of both underreaction (see Hong, Li, and Xu (2019) on how drought indices predict food company stock returns) and overreaction (see Alok, Kumar, and Wermers (2020) on mutual fund performance following natural disasters).…”

Regulating Sustainable Finance in the Dark

“…Thus, the greenium is essentially zero); Murfin and Spiegel (2020) (finding limited price effects of rising sea levels); Baldauf et al (2020) (stating that house prices reflect heterogeneity in beliefs about long-run climate change risks rather than the severity of the risk itself). Against Eichholtz et al (2019) (arguing in favor of a premium for corporate environmental (ESG) performance based on commercial real estate investments); Krueger et al (2020) (arguing that institutional investors believe climate risks have financial implications for their portfolio firms); Alok et al (2020) (finding that managers within a major disaster region underweight disaster zone stocks to a much greater degree than distant managers, indicating a bias); Painter (2020) (finding that counties more likely to be affected by climate change pay more in underwriting fees and initial yields to issue long-term municipal bonds compared to counties unlikely to be affected by climate change); Bernstein et al (2019) (finding that homes exposed to sea level rise (SLR) sell for approximately 7% less than observably equivalent unexposed properties equidistant from the beach); Huynh and Xia (2020) (finding that investors are willing to pay a premium for better environmental performance); Hartzmark and Sussman (2019) (presenting 'causal evidence' from fund inflows that investors market-wide value sustainability). 53 Riedl and Smeets (2017) (finding that investors are willing to forgo financial performance in order to invest in accordance with their social preferences); Joliet and Titova (2018) (arguing that SRI funds add some SRI factors to make investment decisions, and thus more than financial fundamentals matter); Rossi et al (2019) (analyzing retail demand for socially responsible products and finding that social investors are willing to pay a price to be socially responsible while individuals who consider themselves financially literate are less interested in SR products than others); Gutsche and Ziegler (2019) (arguing that a left/green political orientation correlates with the willingness to pay for certified sustainable investments).…”

Environmental Hazards and Risk Management in the Financial Sector: A Systematic Literature Review

“…Due to this poor disclosure, food stock prices are found to underreact to climaterelated risks such as droughts and are thus mispriced by the markets (Hong et al, 2019). For their part, Alok et al (2020) investigate the potential overreaction of professional money managers to climatic disasters and find that investors misestimate climate risks and hold underweight positions in stocks located in disaster zones. Furthermore, this misperception of disaster-driven financial impacts decreases over time and is not related to any information advantages.…”