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 show that investors do not efficiently incorporate the salient information on firms' physical climate change exposures, and firms with high exposures are subject to subsequent lower stock returns. A long-short trading strategy based on the ranking of the exposure produces significant factor-adjusted alphas of around 0.5% per month. We also show that our results cannot be driven by alternative explanations based on hedging against climate change risks, pricing of carbon risks, or concerns for ESG risks. Additionally, we document that the increased public awareness of climate change in recent times has reduced the strength of the predictability relation.