The Connection between Climate Risk and the Global Stock and Bond Markets: A Dynamic Spillover Analysis

Abstract

This paper examines whether climate physical risk affects global stock indices and sovereign bonds. We examine a sample of eight international markets during the period 2000-2022. Using CCC-GARCH and DCC-GARCH models, we document significant overall correlations between climate physical risk and both stock and bond markets in some countries (Japan, the United Kingdom, and Thailand). Moreover, the dynamic correlation follows some patterns. For example, the correlation is more pronounced when the market experiences climate-related disasters, and the spillover effects persist in subsequent periods. This suggests that climate risk is likely to be transmitted to the stock and bond markets, and this effect may persist for a certain period of time. In addition, in Japan both the correlation between climate physical risk and composite index and the correlation between climate physical risk and sovereign bond shift from negative to positive, indicating that the impact of climate risk on financial markets is time varying. These findings provide insights about the dynamic linkages between CRI and global stock and bond markets. They help investors making informed investment decisions across international markets. They also offer guidance for regulators to introduce policies aiming to stabilize financial markets and mitigate the impact of climate risk.

Keywords: Climate change, Climate Physical Risk, Stock Markets, Bond Markets, Spillover Effects, Dynamic Correlation