Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

2021-23 | September 1, 2023

We empirically analyze firm-level uncertainty generated from extreme weather events, guided by a theoretical framework. Stock options of firms with establishments in a hurricane’s (forecast) landfall region exhibit large implied volatility increases, reflecting significant uncertainty (before) after impact. Comparing implied volatility to subsequent realized volatility shows that investors underreact. This underreaction diminishes for hurricanes after Sandy, a salient event that struck the U.S. financial center. Despite constituting idiosyncratic shocks, hurricanes affect hit firms’ expected stock returns. Textual analysis of calls between firm management, analysts, and investors reveals that discussions about hurricane impacts spike during the long-lasting high-uncertainty period after landfall.

Supplemental Appendix (pdf, 1.12 mb)

Article Citation

Roth Tran, Brigitte, Mathias S. Kruttli, and Sumudu W. Watugala. 2021. “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

About the Authors
Abstract image representing a seat vacancy.
Brigitte Roth Tran is a senior economist in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Brigitte Roth Tran
Mathias S. Kruttli is an assistant professor of Finance at Indiana University.
Sumudu W. Watugala is an assistant professor of Finance at Indiana University.