Measuring corporate exposure to weather using linguistic analysis

Recent research shows that weather events impact firms' operational and financial performance, raising the question of whether investors can diversify weather risk. We show that firms' exposure to weather is a systematic non-diversifiable risk, and that this risk is economically significant. We conduct a linguistic analysis of annual reports to derive a new time-varying measure of firm-level exposure to weather. Key innovations of our measure are that it can be easily computed for all public firms and it captures a broad spectrum of weather conditions (as opposed to any single weather condition such as extreme temperatures or rainfalls). After extensively validating our measure, we construct a factor based on this measure. Exposure to this factor is strongly priced by the market. Our study thus highlights the economic importance of weather risk and also answers calls by recent finance studies to build new climate factors and new large-sample measures of firm-level exposure to weather