A0688
Title: Uncovering climate transition risk in FX markets through equity risk premia
Authors: Ana-Maria Fuertes - City University London (United Kingdom) [presenting]
Kate Phylaktis - City University London (United Kingdom)
Zheng Zhang - City University London (United Kingdom)
Abstract: The aim is to investigate whether climate transition risk is priced in foreign exchange (FX) markets and through which channels it transmits. Using monthly data for 35 countries (15 developed, 20 emerging) from 2000 to 2024, it is examined how climate transition risk affects FX returns via equity market risk premia. A dual empirical approach is adopted, combining portfolio-sorting and asset pricing models. Climate transition risk is proxied by a country-level index based on greenhouse gas efficiency and emission pledges. It is found that climate transition risk is significantly priced in emerging markets, especially after the 2015 Paris Agreement. High-risk emerging economies exhibit elevated equity risk premia and negative FX returns, reflecting systematic deviations from uncovered equity parity (UEP). These results are robust across methods, investment horizons, and alternative risk proxies. In contrast, developed markets show no consistent pricing of transition risk. Findings suggest that international investors rebalance portfolios in response to climate policy uncertainty, particularly in less-regulated, more vulnerable markets. This has implications for global capital flows, FX exposure management, and sovereign financing in the low-carbon transition. The results underscore the growing importance of integrating climate risk into currency risk management, especially for policymakers and investors active in emerging markets.
