Climate Risks and Forecasting Stock-Market Returns in Advanced Economies Over a Century

Using monthly data for the eight advanced countries (Canada, France, Germany, Italy, Japan, Switzerland, the United Kingdom (UK), and the United States (US)) over the period from 1916 to 2021, we study whether climate risks have predictive value for stock-market returns. We measure climate risks in terms of both the change in the northern hemisphere temperature anomaly and its volatility and the the change in the global temperature anomaly and its volatility. In our forecasting models, we control for cross-market spillovers of stock-market returns and volatility as well as other risks including oil-price returns and volatility, geopolitical risks, and the gold-to-silver price ratio as a measure of investor risk aversion. Given this large array of control variables, we apply the Lasso estimator to trace out the incremental contribution of climate risks to the predictive performance of our forecasting models. We find that climate risks do not have systematic predictive value for subsequent stock-market returns. Climate risks, however, have short-term out-of-sample predictive value for the connectedness of stock-market returns. Moreover, climate risks have predictive power for stock-market returns when we study historical UK data.