Climate risk and financial systems: A nonlinear network connectedness analysis. (15th August 2023)

• Record Type: Journal Article
• Authors: Mao, Xiaodan; Wei, Ping; Ren, Xiaohang
• Is Part Of: Journal of environmental management. Volume 340(2023)
• Publication Date: 2023-08-15
• Subjects: Climate change -- Climate risk -- Systemic risk -- Network estimation -- Vector autoregression -- Variance decomposition; F3 -- D85 -- G15 -- Q54; Environmental policy -- Periodicals; Environmental management -- Periodicals; Environment -- Periodicals; Ecology -- Periodicals; 363.705
• DOI: 10.1016/j.jenvman.2023.117878
• Languages: English
• ISSNs: 0301-4797

Abstract

Abstract: To deeply analyze and understand the macro-financial impact of climate change, this paper investigates the effect of climate risk on systemic financial risks by employing a network approach. The results demonstrate that climate risk not only affects a single financial market but also induces risk co-movement, which aggravates potential systemic financial risks. Specifically, the system-wide connectedness across the financial system respectively increased by 2.52% and 1.76% after the withdrawal of the US from the Kyoto Protocol and the Copenhagen UN Climate Change Conference. The bond and stock markets are the primary transmitters of climate shocks, while the forex and commodity markets appear to be more sensitive to climate-related information. In addition, the vulnerability of financial asset price fluctuations to climate risk changes substantially over time. Quantile regressions reveal the positive impact of climate risk on total connectedness across the financial system. This study provides novel insight into how the financial system responds to climate-related information and how systemic risk dynamics materialize. Highlights: We provide a dynamic network perspective in our study of the impact of climate risk on financial stability. We examine the transmission channels of climate risk in the financial system. Climate risk causes fluctuations in individual financial markets and increases the interconnectedness among them. The bond and stock markets are particularly instrumental in transmitting climate risk during climate shocks. The impact of climate risk on system-wide connectedness across financial markets varies with different quantiles.