Climate Change Exposure and Stock Return Predictability

This paper finds evidence that stock returns vary with the physical climate change exposure of firms in a predictable manner. We construct measures of exposures to physical climate changes at the firm level, and find that firms with high climate change exposures experience lower future profitability. We show that due to limited attention of investors, stock prices do not promptly incorporate such climate change information, and firms with high climate change exposures are subject to subsequent lower returns. A long-short trading strategy based on this effect produces significant alphas of around 0.6% per month. Moreover, we document that our return predictability strengthens under severe physical climate conditions, and it is not the result of risks associated with carbon emissions