DOES CLIMATE POLICY UNCERTAINTY MOVE WITH STOCK MARKETS? EVIDENCE FROM ADVANCED ECONOMIES WITH THE BEST CLIMATE CHANGE PERFORMANCE

Abstract

This study aims to understand how climate policy uncertainty affects investor behavior and whether it moves with stock markets in advanced economies. Accordingly, we examine data for January 2000-2023 for the stock market indices of Sweden, the United Kingdom, Germany, Norway, the Netherlands, and Finland, which have a ‘good’ CCP rating according to the MSCI classification and the climate policy uncertainty index. Furthermore, we apply two main methodologies: Wavelet Coherence Analysis and the Breitung and Candelon Frequency Causality Test. WCA shows the time-based co-movements between CPU and stock market indices and their effects on each other. We also consider the causality test to examine causality at various frequencies. The WCA results reveal a relationship between the CPU index and all markets except the Norwegian market. As a result of the causality, we conclude that there is a strong causality between the CPU index and the Finnish and Swedish stock markets in the short run, a strong causality between the CPU index and the Dutch market in the long run, and a weak causality between the CPU index and the German stock market in the short, medium and long run. Investors can develop strategies to mitigate risks and hedge volatility by monitoring exogenous factors such as CPU. Strategies such as quick-action stop-loss orders are recommended, especially for short-term CPU-affected markets such as the Swedish and Finnish stock markets.