This paper studies the asset pricing implications of biodiversity physical risk through studying the impact of a novel biodiversity index. A long-short portfolio constructed from firms with low versus high biodiversity physical risk within a given industry generates an average alpha of 2.5% per annum, and such alpha cannot be explained by existing common risk factors. We also document that the predictability of stock returns related to biodiversity physical risk is primarily due to the improper pricing of future cash flows, which is not predicted by financial analysts, by institutional investors, and even after the increase of global attention to biodiversity. We implicates the importance of considering “double materiality” during the evaluation of asset prices under biodiversity-related variables, especially the different impacts of physical and transition risk on asset prices.
