The hidden risk in your portfolio

It’s widely recognized that the financial system is vulnerable to external shocks, with severe events like wars driving equity volatility📉.

🌍 Climate change significantly amplifies market instability📊.

In fact, since 1950, extreme weather events have doubled, with global warming driving storms, floods, heatwaves, rising sea levels🌊, and even the spread of harmful microbes.

For investors, these climate events act as unpredictable shocks, altering their risk appetite. Businesses facing climate risks may resort to layoffs or salary cuts to survive, leading to lower earnings and rising unemployment and, as household and financial expectations drop, investors turn to safer options like government bonds 🏦.

Panic selling can kick in, pushing stock prices down 📉 and further reducing market expectations, ultimately impacting stock yields 💼.

A look at the Data

So, whether it's the signing of international agreements, nuclear disasters, or controversial elections, the stock market quickly reacts to new information about climate risks.

Using event study methodology, researchers have identified clear patterns in how stock market returns react to climate change-related events.

Here are examined four major events:

• Climategate (2009): The email leak from the Climatic Research Unit that spurred climate change skepticism.

• Fukushima (2011): The nuclear disaster that reshaped global energy policies.

• Paris Agreement (2015): The landmark climate accord that set global emissions targets.

• US Presidential Election (2016): Trump's victory, which was seen as a rollback on climate policy.

Here below a first comprehensive analysis of the market reactions after those events

The 5 key dimension of climate change

A study published in Nature used another event study methodology to examine how 526 climate-related disasters across five key dimensions—biological, climatic, geological, hydrological, and meteorological—had affected the stock returns of the NASDAQ 100 index between 2000 and 2019. Here's a breakdown of the findings for each dimension:

1. Biological Dimension 🦠

Biological disasters, such as disease outbreaks (e.g., SARS, COVID-19), significantly impacted stock returns, particularly in the period before 2010. The market showed increased volatility before these events, and returns generally turned negative afterward.

• Key Impacts:

  • Negative returns were sustained due to the prolonged nature of biological events.

  • Pre-2010: Anticipated effects led to increased volatility before the event.

  • Post-Event: Market reactions resulted in lower yields as investors reacted to the uncertainty.

2. Climatic Dimension ☀️❄️

Climatic disasters (e.g., heatwaves, rising sea levels) showed a mixed impact on stock returns. Before 2010, these events had a positive effect on returns, likely due to optimism in renewable energy sectors. After 2010, however, the market’s response shifted toward more volatility and long-term negative impacts.

• Key Impacts:

  • 2000-2009: Positive returns before events.

  • 2010-2019: Greater volatility, with a more prolonged negative impact.

  • Increased Market Sensitivity: As extreme climate events worsened, the market exhibited both short-term shocks and long-term volatility.

3. Geological Dimension 🌋

Geological events (e.g., earthquakes, landslides) showed a sharp negative impact on stock returns but for a relatively short period. The market typically reacted swiftly to these events, but the impact faded quickly as recovery efforts stabilized the situation.

• Key Impacts:

  • Short-lived but intense shocks immediately after disasters.

  • 2000-2009: Significant increase in stock returns within 10 days after geological disasters.

  • 2010-2019: Decreased returns within 5 days, reflecting more short-term focus.

4. Hydrological Dimension 🌊🚤

Water-related disasters (e.g., floods, droughts) produced negative returns, especially post-2010. Hydrological events caused prolonged negative impacts, with a slower recovery process than other disaster types.

• Key Impacts:

  • 2000-2009: Quick recovery, turning positive 5 days after the event.

  • 2010-2019: More persistent negative returns, with a stronger market reaction to drought and flood risks.

  • Time-varying effect: The long-term shock effect has increased over time.

5. Meteorological Dimension 🌪️🌧️

Meteorological disasters (e.g., hurricanes, storms) had a mixed effect depending on the time period. Before 2010, the market overreacted to these events but corrected itself afterward. Post-2010, meteorological events caused a stronger and more prolonged negative impact.

• Key Impacts:

  • 2000-2009: Initial market overreaction before the disaster, followed by a gradual correction.

  • 2010-2019: Persistent negative returns, showing increased sensitivity to extreme weather events.

Conclusion 📊🌐

Overall, climate change exerts non-linear and time-varying effects on stock returns:

• Biological and hydrological dimensions have consistent negative impacts.

• Climatic and meteorological dimensions have increased volatility over time, highlighting greater investor caution.

• Geological events remain short-term disruptions with limited long-term consequences.

As climate-related events grow in intensity and frequency, it becomes increasingly important for investors, businesses, and policymakers to integrate climate risk into decision-making. 🌿

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