Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

Author(s): Mathias S. Kruttli, Brigitte Roth Tran, and Sumudu W. Watugala

We present a framework to identify market responses to firm-level uncertainty generated from extreme weather events. The stock options of firms with establishments in a hurricane’s landfall region exhibit large, long-lasting implied volatility increases, reflecting significant uncertainty. Comparing implied volatility to subsequent realized volatility, we find that investors underreact. After Hurricane Sandy, a particularly damaging event whose landfall struck the U.S. financial center, this underreaction diminishes. Despite constituting idiosyncratic volatility shocks, hurricanes affect expected returns. Discussions between analysts, investors, and management about hurricane impacts are elevated while uncertainty is high and reveal business interruption, physical damages, insurance, and demand as predominant channels.

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Article Citation

Kruttli, Mathias S, Brigitte Roth Tran, and Sumudu W. Watugala. 2023. "Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics," Federal Reserve Bank of San Francisco Working Paper 2021-23. Available at https://doi.org/10.24148/wp2021-23