M. Kruttli, B. Roth Tran, S. Watugala: Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics

September 11, 2019

This paper investigates the uncertainty dynamics surrounding extreme weather events through the lens of financial markets. Our framework identifies market responses to the uncertainty regarding both potential hurricane landfall and subsequent economic impact. Stock options on firms with establishments exposed to the landfall region exhibit large increases in implied volatility of up to 30 percent, reflecting impact uncertainty. Impact uncertainty persists for several months after landfall. Using hurricane forecasts, we show both landfall uncertainty and potential impact uncertainty are reflected in option prices before landfall.