Financial markets value skillful forecasts of seasonal climate

Derek Lemoine & Sarah Kapnick, Nature Communications

Financial markets value skillful forecasts of seasonal climate
Benjamin Lindgreen, Unsplash

Scientific agencies spend substantial sums producing and improving forecasts of seasonal climate, but they do so without much information about these forecasts’ value in practice. Here we show that financial market participants value the production of seasonal forecasts: options traders price the uncertainty generated by upcoming United States National Oceanic and Atmospheric Administration Winter and El Niño Outlooks. Each outlook affects firms throughout the economy, with total market capitalization of $6 and $13 trillion, respectively. A 1% improvement in the skill of the El Niño Outlook reduces firms’ exposure to a one standard deviation shock by $18 billion and induces traders to spend an additional $2 million hedging the outlook’s news. Firms must not be able to undertake ex-ante adaptation that would eliminate their exposure to the forecasted portion of seasonal climate without imposing substantial costs of its own.

Read the full paper here

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