RESEARCH
Taking Stock of How Weather Affects Investing
Weather is said to affect our demeanor, influencing our ability to focus, remember and even think critically. According to a recent research paper by Danling Jiang, professor of finance and associate dean of research and faculty development in Stony Brook University’s College of Business, it also affects the way we invest.
Jiang’s research focuses on understanding how psychology impacts financial markets. “Weather, Institutional Investors, and Earnings News,” published in April, is one of several studies in which Jiang has explored the power of investor psychology in shaping financial market outcomes.
“The research team also includes Lin Sun of George Mason University and Dylan Norris of Troy University, who were colleagues several years ago,” said Jiang. “We were fascinated by the idea presented in prior research that weather seems a perfect exogenous shock to investor psychology and physiology. This allows us to draw some causality of psychology on market pricing in a new setting with institutional investors and earnings announcements.”
Jiang’s study looks at the weather across all U.S. cities where major institutional investors are headquartered prior to earnings announcements. The key weather measures — “cloud cover” and “unpleasant weather,” a combination of cloud cover, precipitation and wind speed — are the holding-weighted average weather condition across the firm’s top ten institutional investors’ locations. Previous studies have focused on New York City weather and its impact on market pricing.
“We created a separate severe weather measure as a control for physical impediments to investors’ actions,” said Jiang. “For instance, a blizzard or hurricane may prevent an investor from getting to work or being able to work in the event power is lost. The severe weather measure includes incidences of extreme weather, weather that can cause death, injury, damage, occurring near an institutional investors’ location around an earnings announcement date. But we do not find a significant impact from severe weather.”
Looking at data from 1990 to 2016, Jiang’s research team found that a one-standard-deviation increase in pre-announcement unpleasant weather leads to a 45-basis-point smaller spread between top and bottom surprises, a difference of about 10 percent. They also found reduced trading activity during unpleasant weather.
“Both of our weather measures are deseasonalized,” said Jiang. “By that, we mean that the measure is the difference between observed weather and the average weather observed in the same month and for the same area over the entire sample period, which was 17 years. Using these deseasonalized measures allows us to capture the ‘unexpected’ weather relative to ‘normal’ conditions.”
In an efficient market, Jiang said earnings news would be reflected in the stock price quickly and accurately. Her research, however, suggests that pre-announcement unpleasant weather results in a delayed or muted reaction to earnings news. Additionally, the three-day announcement reaction is weaker when institution-experienced pre-announcement weather is unpleasant.
Jiang said that this initial underreaction appears to correct itself over time, adding that “this is shown in the post-earnings-announcement drift, where we find pre-announcement unpleasant weather predicts stronger post-announcement drift in the next 2-3 months.”
You may be asking, “Can Wall Street traders leverage these findings to develop strategies that take advantage of weather-induced post-earnings announcement drift patterns?” Jiang says yes, but cautions that such strategies carry risks, especially in the short term.
“Perhaps the more useful takeaway is the power of psychological biases and physiological constraints, even among institutional investors revered as being more sophisticated than the average retail trader,” said Jiang, who dedicates time to helping young entrepreneurs achieve financial responsibility and intelligence.
“Our study joins a growing collection showing psychological biases and physiological constraints that affect institutional investor decision-making and impact security pricing. If investors realize that they are susceptible to such influences, they may be better prepared to avoid making biased decisions.”
— Robert Emproto