Can Variations in Temperature Explain the Systemic Risk of European Firms?

Abstract

We employ a CoVaR model in order to measure the potential impact of temperature fluctuations on systemic risk, considering all companies from the STOXX Europe 600 Index, which covers a wide range of industries for the period from 1/1/1990 to 29/12/2017. Furthermore, in this study, we decompose temperature into 3 factors; namely (1) trend, (2) seasonality and (3) anomaly. Findings suggest that, temperature has indeed a significant impact on systemic risk. In fact, we provide significant evidence of either positive or nonlinear temperature effects on financial markets, while the nonlinear relationship between temperature and systemic risk follows an inverted U-shaped curve. In addition, hot temperature shocks strongly increase systemic risk, while we do witness the opposite for cold shocks. Additional analysis shows that deviations of temperature by 1 • C can increase the daily Value at Risk by up to 0.24 basis points. Overall, higher temperatures are highly detrimental for the financial system. Results remain robust under the different proxies that were employed to capture systemic risk or temperature.

Temperature Variability and the Macroeconomy: A World Tour

“…Balvers et al (2017) find also that temperature shocks (on average) generate a increase in the cost of capital. Focusing on all companies listed in the STOXX Europe 600 Index, Tzouvanas et al (2019) observe that higher temperatures are highly detrimental for the financial system. In particular, hot temperature shocks are found to be responsible for a significant increase in systemic risk.…”

Air temperature and sovereign bond returns

“…The presence of non-linearities is also informed by Tzouvanas et al (2019), who model variations in the systemic risk of EU manufacturing companies as a quadratic function of temperature and provide evidence that the latter has a significant impact on systemic risk. Therefore, our models are designed to address nonlinear temperature effects on sovereign bond returns.…”

“…Moreover, our study significantly adds to the asset pricing literature, founded on the macroeconomic, behavioral and energy demand-based paradigms. Whereas existing literature has explored this phenomenon in the stock market (Cao & Wei, 2005b;Chang et al, 2006;He & Ma, 2021;Tzouvanas et al, 2019;Yoon & Kang, 2009), other asset classes remain a largely unchartered territory. Andrikopoulos et al (2019), who examined currencies, and Makkonen et al ( 2021)whose research centred on commodities-are the exceptions to this notion.…”

Can market risk explain the systemic risk? Evidence from the US banking industry

“…A growing body of literature has sought to understand the relationship between financial risk and systemic risk (see, e.g. Adrian and Brunnermeier, 2016; Adrian and Boyarchenko, 2018; Avdjiev et al ., 2020; Brownlees and Engle, 2017; Hwang et al ., 2017; Kuttner and Shim, 2016; Tzouvanas et al ., 2019), and to identify the factors that contribute to the amplification and transmission of risk across the financial system.…”

“…Besides financial risk, other risks associated with systemic risk are climate-related (physical and transition risks), pandemics (COVID-19) and other political risks (e.g. wars) (Battiston et al ., 2021; Rizwan et al ., 2020; Tzouvanas et al ., 2019; Qureshi et al ., 2022). However, the role of market risk, such as idiosyncratic and systematic risks, has been neglected in this strand of literature.…”