The effect of weather on stock returns: A comparison between emerging and developed markets by Irina Prodan

Introduction 
Advocates of the efficient market hypothesis argue that security markets are rational and that prices on 
these markets reflect the underlying economic fundamentals (Fama, 1970). Nevertheless, numerous 
market anomalies came to light over the past decades. A prominent complementary paradigm is that 
investors’ trading behavior is shaped by psychological influences which are considered irrational. 
Shiller (2003) argues that this division of the financial literature - behavioral finance - is one of the 
most vital research areas. 
One renowned and frequently researched anomaly over the last two decades, especially in the last 
years, is the weather effect. This can be defined as the effect that weather, measured using a variety of 
quantitative meteorological variables, has on the stock market returns. As argued by behavioral fi-

nance, economic agents have bounded rationality, allowing subjective factors to influence their deci-

sion making process. The weather effect is a pertaining component of this theory that can be placed 
within the psychology block of behavioral economics (Barberis and Thaler, 2003). 
The extensive literature upon the weather effect has led to conflicting results. Starting with Saunders 
(1993), a considerable number of studies have found evidence supporting the impact that weather has 
on investors’ mood and consequently on stock market activity. Further investigation and a variety of 
methodological approaches have revealed a lack of results consistency. The weather effect has been 
discovered to exist in many countries – United States, Taiwan, Thailand, Finland, but critics followed 
as well. Most opponent papers are in favor of a weak form of efficient market and claim that the exist-

ence of the weather effect is merely a result of inaccurate data definition, discontinuous records and 
data mining. 
Given these prior contradictory results, our research study investigates whether emerging stock mar-

kets are prone to deviate from fundamentals and to display a persistent weather influence relative to 
developed and more efficient markets. In this paper, our aim is to test whether stock prices are affected 
by weather in a significantly different manner depending on the level of market development. A sig-

nificant difference would then explain why financial literature on the weather effect is devoid of con-

sensus. 
We expect that the weather effect is more important in emerging countries relative to developed ones 
based on two arguments. First, emerging markets are more likely to be inefficient compared to devel-

oped countries (Harvey, 1994); therefore, stock markets are more exposed to anomalies that can be 
explained throughout means of behavioral finance. Secondly, the proportion of local investors to for-

eign investors is higher in developing countries (Korajczyk, 1996), which could mean that these mar-

kets are more influenced by a set of common factors and local conditions that affect local investors – 
such as weather. 
We demonstrate, however, that there is no difference in the weather effect between developed and 
emerging countries. Also, we find evidence of a cyclical pattern of the weather effect. For both types 
of countries the weather effect is small (if existing) and the significance of the influence of weather is 
declining over time. Within the cyclical pattern of the weather effect, we identify a breakpoint for 
developed countries around the year 2001, followed by a breakpoint for emerging countries around the 
year 2002. Furthermore, although there is no difference in the significance of the weather effect in 
emerging and developed countries, we show that emerging countries are relatively less efficient than 
developed countries. 
The remainder of this paper is organized as follows. Section 2 provides a review of the literature on 
the weather effect, followed by a description of the data collection process and data analysis in Section 
3. The methodology and the results for the different tests are presented in Section 4. We check for 
robustness to seasonal adjustment method in Section 5. Finally, we provide some potential explana-

tions of our findings in Section 6 and present the conclusions of this study in Section 7. 
2. Literature review 
The literature investigating the relationship between the weather and the stock market prices considers 
two distinct sections. First, psychology literature supports and explains the connection between weath-

er and mood and the further link between mood and behavior. Second, financial literature can be used 
to explore previous research on the relationship between weather and the behavior of investors on 
stock markets while connecting it to stock market quantitative variables.

sychology literature - according to our knowledge – has not examined the direct link between weath-

er and investors’ behavior on the stock market. Therefore, we make use of the reasoning applied in all 
the previous financial literature on the weather effect: weather affects the mood of investors, the mood 
of investors influence investors’ behavior and this reflects straightforward in stock market trading 
activity (figure 1).

The effect of weather on stock returns: A comparison between emerging and developed markets by Irina Prodan