What drives the cross-border spillover of climate transition risks? Evidence from global stock markets

Abstract

Despite increasing efforts to better understand the financial consequences of climate change, the question of how climate-related financial risks could spill over across borders remains largely unexplored. By studying the role of countries’ climate transition risks in the bilateral co-movement of stock market returns in 42 countries, this paper finds that climate transition risks could increase the co-movement of stock market returns. The effect of climate transition risks increases with greater similarity of economic conditions and a higher dependence on import between two countries, which we interpret as a proof of cross-border climate transition risk spillover. While good country performances in combating climate change can help reduce the impact, an effective mitigation likely requires good performances by both. Our results suggest that countries with lower transition risks are not immune to the impact of climate change risks because of the potential for international spillover, and there is a strong need for international efforts to deal with the risks of climate change to financial stability.