International Stock Markets’ Reactions to EU Climate Policy Shocks

While policies to combat climate change are designed to address a global problem, they are generally implemented at the national level. Nevertheless, the impact of domestic climate policies may spill over internationally given countries’ economic and financial interdependence. For example, a carbon tax charged to domestic firms for their use of fossil fuels may lead the firms to charge higher prices to their domestic and foreign customers; given the importance of global value chains in modern economies, the impact of that carbon tax may propagate across multiple layers of cross-border production linkages. In this post, we quantify the spillover effects of climate policies on forward-looking asset prices globally by estimating the impact of carbon price shocks in the European Union’s Emissions Trading System (EU ETS) on stock prices across a broad set of country-industry pairs. In other words, we measure how asset markets evaluate the impact of changes to the carbon price on growth and profitability prospects of the firms.