What Drives the Cross-Border Spillover of Climate Transition Risks? Evidence from Global Stock Markets

This working paper was written by Gabriel Wu (Hong Kong Monetary Authority) and Wilson Wan (Hong Kong Monetary Authority).Despite the increasing efforts to better understand the financial consequences of climate change, how climate-related financial risks could spill over across borders largely remain unexplored. This paper finds that climate transition risks could spill across borders by increasing the bilateral co-movement of stock market returns. The effect of climate transition risks increases with greater similarity of economic condition and larger dependence on import between two countries. On the other hand, good country performances in combating climate change can help to reduce the impact, but an effective mitigation likely requires good performances by both. Our resultshave three implications. First, evidence of stock market co-movement due to climate transition risks suggests international stock market investors may have to consider such spillover risks in their risk management practice. This necessitates continuous improvements in climate risk disclosures by corporates and financial institutions. Secondly, the cross-border spillover of climate transition risks is a global rather than a regional issue. A country with lower transition risks is not immune to the impact of climate change risks because of the potential for international spillover. Thirdly, our findings highlight a strong need for international efforts to deal with the risks of climate change to financial stability