Accounting Seminar: Professor Cameron Troung
Climate Risk: The Price of Drought
We document a significant positive relation between climate change risks in the form of drought and the cost of funding of affected firms as proxied by the implied cost of equity, corporate bond yields, SEO underpricing, and future realized stock returns. Consistent with predictions from disaster risk theories, we find that drought duration and drought intensity further increase a firm’s risk premium. However, for firms with diversified cash flows/investments, geographically dispersed business operations, and high cash holdings, the impact of drought on the expected return is significantly mitigated. We also document a positive relation between drought and firm risk and an inverse relation between drought and state-level GDP growth and consumption growth. Overall, our findings support the notion that climate change risks are not easily diversifiable and the market prices these risks into the firm-level risk premium.