Three essays in climate finance

This thesis consists of three essays that study the impact of climate risk on financial markets and participants. In the second chapter, we find that firms' exposure to temperature changes predicts stock returns. We use the sensitivity of stock returns to abnormal temperature changes to measure firm-level climate sensitivity. Stocks with higher climate sensitivity forecast lower stock returns. A trading strategy that exploits return predictability generates risk-adjusted returns of 4% per year from 1968 to 2019. Such abnormal returns disappear after one year. Further, climate sensitivity predicts lower earnings, sales and margin profits. Firms with high climate sensitivity also perform worse in ESG scores. Overall, these findings are consistent with stock markets underreacting to firms' climate sensitivity. In the third chapter, we examine whether sell-side equity analysts help the market assimilate information contained in global climate change. Using a new measure of firm sensitivity to climate change, we show that analysts located in states where firms exhibit greater sensitivity to abnormal temperature changes issue relatively more accurate forecasts in periods following large temperature increases. These effects are stronger for firms that are more sensitive to temperature changes. High temperature sensitivity firms also have lower consensus forecasts and higher earnings surprises, which generate higher stock market reactions following earnings announcements. Collectively, the evidence suggests that certain sell-side equity analysts incorporate news about climate change in their earnings forecasts and, consequently, earnings information is incorporated into prices quicker. The fourth chapter document how climate risk affects institutional investors by investigating if they change their holding strategy according to firm-level climate sensitivity. We find that institutional investors ownership of high climate sensitivity stocks is lower. Institutional investors show better skill in high climate sensitivity stocks holding, and low abnormal stock returns of high climate sensitivity stocks are mostly generated from retail investors. Besides, several types of institutional investors have different preferences for high climate sensitivity stocks than others. Aggressive institutional investors react to climate risk better than conservative institutional investors do. We also find that the location of institutional investors does not affect their holding strategy on high climate sensitivity stocks. Collectively, our findings suggest that part of the institutional investors realize the climate risk and react to it