Biological and Environmental Research - Earth and Environmental System Sciences
Earth and Environmental System Modeling

Market expectations of a warming climate

TitleMarket expectations of a warming climate
Publication TypeJournal Article
Year of Publication2021
JournalJournal of Financial Economics
Abstract / Summary

We compare prices of financial derivatives whose payouts are based on future weather outcomes to CMIP5 climate model predictions as well as observed weather station data across eight cities in the US from 2001 through 2020. Derivative prices respond both to short-term weather forecasts for the next two weeks and longer-term warming trends. We show that the long-term trends in derivative prices are comparable to station-level data and climate model output. The one exception is February in the northeastern US, where financial markets price in a polar vortex-induced cooling effect, a recent scientific finding that was not present in the older CMIP5 climate output. When looking at the spatial and temporal heterogeneity in trends, futures prices are more aligned with climate model output than observed weather station trends, suggesting that market participants closely align their expectations with scientific projections rather than recent observations.

URLhttp://dx.doi.org/10.1016/j.jfineco.2020.08.019
DOI10.1016/j.jfineco.2020.08.019
Funding Program: 
Journal: Journal of Financial Economics
Year of Publication: 2021
Publication Date: 04/2021

We compare prices of financial derivatives whose payouts are based on future weather outcomes to CMIP5 climate model predictions as well as observed weather station data across eight cities in the US from 2001 through 2020. Derivative prices respond both to short-term weather forecasts for the next two weeks and longer-term warming trends. We show that the long-term trends in derivative prices are comparable to station-level data and climate model output. The one exception is February in the northeastern US, where financial markets price in a polar vortex-induced cooling effect, a recent scientific finding that was not present in the older CMIP5 climate output. When looking at the spatial and temporal heterogeneity in trends, futures prices are more aligned with climate model output than observed weather station trends, suggesting that market participants closely align their expectations with scientific projections rather than recent observations.

DOI: 10.1016/j.jfineco.2020.08.019
Citation:
Schlenker, W, and C Taylor.  2021.  "Market expectations of a warming climate."  Journal of Financial Economics.  https://doi.org/10.1016/j.jfineco.2020.08.019.