The extreme temperature factor in asset pricing models: Evidence from Europe

Growing concern about climate change has led to increased research into the effects of climate on markets. One of the weather variables studied is temperature. The previous studies considered that the temperature influences on asset returns through changes in investor mood. There are few studies tha...

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Bibliographic Details
Published in:Finance research letters 2024-08, Vol.66, p.105620, Article 105620
Main Authors: González-Sánchez, Mariano, Arguedas Sanz, Raquel, Segovia San Juan, Ana I.
Format: Article
Language:English
Subjects:
Asset pricing model
Multifactor model
Temperature factor
Temperature shocks
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Summary:Growing concern about climate change has led to increased research into the effects of climate on markets. One of the weather variables studied is temperature. The previous studies considered that the temperature influences on asset returns through changes in investor mood. There are few studies that incorporate a risk factor to analyze the effects of temperature changes on asset returns. We extract positive and negative extreme temperature changes to design three temperature factors. By a cross-section asset pricing model, we find evidence that temperature shocks (hot and cold) show a significant monthly risk premium and skewness for temperature changes. •We calculate the sensitivity of asset returns to the temperature extreme changes.•Asset pricing factor consists up asset return with more sensitivity to temperature.•Temperature shocks show a significant monthly risk premium and better model fit.
ISSN:1544-6123
1544-6131
DOI:10.1016/j.frl.2024.105620