When Climate Risks Meet Equity Markets: Evidence from Return and Volatility Spillovers

Climate change presents significant risks to the global economy and financial markets through both physical and transition channels. This study examines the transmission of climate-related risks, measured by two news-based indicators—the Physical Risk Index (PRI) and the Transition Risk Index (TRI)—to equity markets. Using the Diebold–Yilmaz and Baruník–Křehlík connectedness frameworks, we analyze three representative equity benchmarks: the S&P 500 (SP500), the iShares ESG MSCI KLD 400 Index (DSI), and the iShares Global Clean Energy Index (ICLN). The empirical results show three main findings. First, both the PRI and TRI have relatively weak spillover effects on equity markets but display strong mutual interactions, indicating interdependence between physical and transition risk dimensions. Second, return spillovers are more prominent in the short term, while volatility spillovers dominate over longer horizons, reflecting structural asymmetry in risk transmission. Third, major global shocks—including the 2011 Libyan conflict, the COVID-19 pandemic, and U.S. tariff shocks in 2018 and 2025—increase both return and volatility spillovers. Overall, the findings indicate that volatility is the primary channel for long-term transmission of climate-related uncertainty. Climate-related news, although not yet fully integrated into equity market dynamics, is increasingly relevant for financial stability and the broader energy transition. Therefore, incorporating climate risk considerations into financial market analysis and policy design is necessary.