Asleep at the Wheel? The Risk of Sudden Price Adjustments

The Journal of Portfolio Management, Novel Risks and Sources of Volatility Special Issue, Vol 50, Number 2, December 2023

A large number of studies have failed to identify a robust and economically significant climate risk premium or climate beta, either at the aggregate or at the sectoral level. The author examines several explanations of why this may be the case and finds that a mispricing of climate risk is the most likely explanation. If this is true, price adjustments will eventually occur, either in a gradual or in an abrupt way. This is a novel source of risk that should be on the radar screen of long-term investors.

Key findings:

• The author considers the possibility that climate risk may not be fully reflected in asset prices.
• The price adjustment for climate risk should be large both in the case of successful tackling of the climate change problem and in the case of delayed action—yet statistical studies show very little price responsiveness to climate news.
• The possibility of a late recognition of the necessary price adjustment is considered, and it is argued that the severity of the adjustment could be enhanced if the readjustment is sudden.

Article accessible in open access here: https://eprints.pm-research.com/17511/102263/index.html?90126