Do the financial markets of developing nations catch the shocks when the developed countries sneeze? An insight into climate policy initiatives

PurposeThis paper aims to uncover the volatility spillover from developed financial markets to developing financial markets with respect to climate policy initiatives. For the same, the carbon-efficient index of three developed markets (the USA, Europe and Japan) along with the global carbon-efficient index and carbon-efficient index of developing countries (India, China and South Africa) are considered. In addition, it also analyses the recipient and transmission of the shocks among the examined indices.Design/methodology/approachThis study uses Dynamic Conditional Correlation-Generalized Autoregressive Conditional Heteroskedasticity and the Diebold–Yilmaz (2012) models to examine the cross-market dynamic connectedness among carbon-efficient indices of select countries. The empirical investigation is based on daily observation of carbon-efficient indices of select countries spanning from 22/10/2018 to 22/03/2024.FindingsThis study reveals mixed forms of spillover effects from developed to developing carbon-efficient markets. In the short run, it reveals no cross-market connectedness from the US carbon market to select developing economies, while there is a transmission seen from Europe to China, Japan to China and the global carbon index to India. Similarly, mixed results are found in the long run. Concerning net connectedness, the authors found that the carbon indices of the USA, Europe and global as net transmitters while Japan, India, China and South Africa emerged as the net receivers of the shocks.Research limitations/implicationsAdvanced econometric models have been used for this study, providing crucial insights into the impact on the developing countries’ financial markets by the developed countries’ climate policy initiatives. The findings stress the need for policymakers in developing countries to deliberate external climate policy shocks in their financial strategies, enhancing market resilience.Practical implicationsThe study emphasizes the importance of progressive risk management strategies for investors and financial professionals, considering the dynamics of interconnectedness and market volatility of developed and developing nations. Awareness of these relationships can guide better portfolio management and investment decisions, especially in regions prone to large external shocks.Social implicationsThis manuscript looks into the implications for socio-economic stability in vulnerable regions while emphasizing the economic interdependence between developed and developing nations. These dynamics should be considered by policymakers when developing strategies to mitigate negative effects and promote long-term growth, ensuring that global policy shifts do not disproportionately harm developing economies.Originality/valueThis research adds new insights into the financial implications of climate policies, helping to better understand the complex interdependence of carbon-efficient indices among developed and developing nations.