Temperature, Growth, and Asset Prices

This article makes a contribution towards understanding the impact of temperature fluctuations on the economy and financial markets. Using historical aggregate U.S. data we show that temperature negatively impacts future growth up to 10 years. We present a long-run risks model with temperature related natural disasters. The model simultaneously matches observed temperature and consumption growth dynamics, and key features of financial markets data. We use this model to evaluate the role of temperature in determining asset prices, and to compute utility-based welfare costs as well as dollar costs of insuring against temperature fluctuations. We find that the temperature related utility-costs are about 7% of consumption, and the total dollar costs of completely insuring against temperature variation are about 104% of GDP. We show that the same features, long-run risks and recursive-preferences, that account for the risk-free rate and the equity premium puzzles also imply that temperaturerelated economic costs are high. Our model implies that a rise in global temperature lowers equity valuations and raises risk premiums.