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AUG. 13, 2021

The Heat Is On

After a few grey and rainy weeks, summer has finally arrived in Zurich as well.

In general, the sun and the heat influence the quantity and the quality of time spent outside. What influence, however, do they have on financial markets? Odd as the question may sound, the recent increased awareness on the environment and on climate change, has led various academics to focus their research on this particular topic.

Heatwaves can affect stock market prices, with some companies losing up to 2% of their market value due to investor perception of climate risk, according to a University of Otago study (Extreme high surface temperature events and equity-related physical climate risk - 2019). The study found that equity markets experienced an average 0.42% loss in the first 20 days of a heat wave. In addition, longer heatwaves are associated with heavier losses. Investor losses were on average 1.38% during more severe weather events, with small cap companies being more vulnerable, registering losses of 1-2% of their market value.

What is the driver of this investor behavior? A recent MIT study (Can You Feel the Heat? Extreme Temperatures, Stock Returns, and Economic Sentiment - 2018) uses survey data to show that very hot and very cold temperatures make individuals more pessimistic about the environment and alter the trading behavior of the marginal investor by reducing stock returns. These effects are concentrated among college educated workers and those in higher skilled jobs who face greater cognitive demands in their job. This increased pessimism can have persistent effects on investor sentiment and investor confidence. Climate shocks such as hurricanes can lead to protracted periods of economic stagnation.

Finally, the trades of pessimistic investors initiated during heatwaves are likely to have a larger price impact due to the lower liquidity during the summer months. A group of French researchers (Extreme heat and stock market activity – 2021) identified the cause of the lower liquidity in the increased tiredness, bad mood, and distraction of investors during heatwaves, all factors that diminish investors’ propensity to trade.

These studies together point in the direction of a “Hot Weather” effect in financial markets, something we remain aware of, while focusing our attention on the themes shaping the markets.

We thank you for the continued support.

The FAM team