Climate policy uncertainty risk and sovereign bond volatility

Abstract

This study investigates the relationship between climate policy uncertainty (CPU) risk and the volatility of sovereign bond return (SBV) in 43 economies from 2012 to 2021. It also innovatively examines how the volatility and asymmetry of CPU affect SBV. The study utilizes the GARCH-MIDAS model to handle mixed-frequency data and applies the DCC-GARCH and TVP-VAR-DY models to investigate dynamic correlations and spillover effects. The empirical results show that CPU negatively impacts SBV, while CPU's volatility or positive shocks tend to elevate SBV, especially in more climate-resilient developed economies. In addition, critical international events can influence dynamic correlations and spillover effects between CPU (or its volatility) and SBV, particularly when climate policy is highly valued. From a risk transmission standpoint within the sovereign bond system, CPU and its volatility exert positive net spillover effects on SBV in the majority of economies. This study offers valuable insights for investors and policymakers, aligning with the goals of sustainable development for effective management of CPU risks.