Volatile temperatures and their effects on equity returns and firm performance

Using temperature variability to assess climate risk

Their paper explores how changes in temperature anomalies, particularly variability, influence corporate profitability, returns, and investor attention, proposing temperature variability as a financially material metric for assessing climate-related physical risks.

The researchers use temperature variability (standard deviation) and mean changes in temperature anomalies as key metrics, derived from surface temperature data aggregated at the state level in the U.S. Temperature variability, rather than mean temperature, has a significant financial impact on firms. Specifically, quarterly firm return-on-assets declines with greater temperature variability, reflecting fundamental shifts in firm value. These effects are driven by reductions in consumer demand and number of hours worked, alongside changes in media and investor attention.

The authors present a geographically scalable statistical framework to quantify the effects of climate-related physical risks, such as shifts in temperature distribution. This metric offers a pathway to improving the disclosure of material climate risks, helping firms, investors, and government agencies address the climate risk information gap.

Key points for decision-makers

Unstandardised disclosure practices

Current regulations for disclosing climate-related financial risks are inconsistent and often lack a basis in financial materiality.

A robust metric for material risks

The authors propose a robust method to quantify the financial materiality of changing temperature distributions, enabling standardized, quantitative, and comparable disclosures of material temperature risks causally linked to financial, behavioural, and economic outcomes.

Empirical evidence via portfolio strategy

Using a geographic long–short portfolio strategy with Russell 3,000 firms (the largest U.S. companies), the study examines state-level exposure to mean temperature changes and temperature variability on returns (2005–2019). The results show that equities respond to shifts in temperature variability but not to mean temperature changes.

Drivers of financial impact

Temperature variability is amplified by media attention, affects investor beliefs and behaviour, reduces working hours (notably in sectors like construction, durables, and hospitality), and decreases consumption all of which affect firm value.

Practical applications

Firms can use the temperature variability metric to report their exposure to future temperature risks, enabling better communication with financial markets about their vulnerability to climate-related temperature shocks. Investors can leverage this metric to evaluate company exposures within their portfolios over relevant time horizons and adjust allocations to minimize portfolio exposure to temperature variability risks.

Read the full paper: Volatile Temperatures and their Effects on Equity Returns and Firm Performance

Luca Taschini is Chair in Climate Change Finance at the University of Edinburgh Business School.

Atreya Dey is a Research Assistant at the University of Edinburgh Business School.