Weathering market swings: Does climate risk matter for agricultural commodity price predictability?

The challenges posed by climate change on the agricultural market have become a pressing concern. An accurate reading of future agricultural commodity prices can be an invaluable planning instrument for diverse interested parties. Here, we explore asset pricing implications of climate risk for the agricultural commodity market from January 2005 to December 2021. Through introducing a composite climate risk index based on the four individual climate risk measures of Faccini et al. (2023), our findings provide valuable insights into the time-series predictability of aggregate climate risk on future agricultural commodity returns, both in- and out-of-sample. This powerful predictability conveys substantial economic benefits to mean–variance investors and cannot be subsumed by conventional economic predictor variables. The evidence further suggests that physical risk, especially global warming, exhibits much stronger return predictability than transition risk. Moreover, we emphasize the pivotal role of climate risk in shaping supply dynamics and capturing investor attention, thereby serving as potential drivers of return predictability. Overall, these predictive insights hold important implications for risk management, investment strategies, and policy formulation in the agricultural commodity market.