The Role of Political Uncertainty in the Impact of Climate-Related Disasters on Financial Markets

Abstract This paper proposes a disaster DGSE model with political uncertainty to examine the future implications of climate disasters on financial markets. The model predicts that there are three additional risk factors due to this specification: climatic disaster risk, political uncertainty risk, and a combination of political uncertainty risk due to climatic disasters. The estimated risk premium of climatic disaster risk puts the economic decrease due to climatic disasters to be -6.30% of GDP, well in excess of predictions for the amount of temperature increase experienced thus far. It is found that the positive risk premium earned by climatic disaster risk is partially offset by the negative risk premium earned from the political uncertainty risk due to climatic disasters. In short, the government guarantee to offset climatic damage has shielded the economy from the effects of climatic disasters. Thus, to hedge future growing climatic disasters is to partially hedge future political uncertainty over the future value of the government's guarantee. JEL Codes: G00, G12