Is Flood Risk Priced in Bank Returns?

Abstract

I quantify the costs of realized flood disasters for banks and create a novel measure of bank-level flood risk exposure using expected flood risk estimates and mortgage lending data. I document that banks with large shares of mortgages in affected areas experience lower profits and capital ratios following flood disasters. In the cross-section of stock returns, small banks with high exposure to flood risk underperform other banks, on average, by up to 9.6% per year; this implies that exposure to flood is not fully priced. Underperformance persists when controlling for the negative effects of disasters on realized returns and adjusting for investors’ climate change concerns. The findings support regulatory concerns that bank equity is exposed to physical risk from climate change.