Climate policy uncertainty, regulation, and exchange rate risk: Evidence from news-based indices and spillover models

Climate policy uncertainty (CPU) has emerged as a critical but understudied source of financial risk, particularly in foreign exchange (FX) markets. This paper examines how the CPU influences exchange rate volatility and cross-currency spillovers by analyzing daily data from 2015 to 2023 on six major currency pairs. The results show that periods of elevated CPU increase exchange rate volatility by up to 30 percent in carbon-intensive and emerging economies, with RUB/USD and CNY/USD consistently acting as net transmitters of risk. The total connectedness index (TCI) reaches 42.7 percent, indicating that the CPU generates systemic spillovers across currency markets rather than isolated shocks. These findings extend prior research that focused mainly on equity and bond markets, highlighting the unique vulnerabilities of FX markets to climate policy narratives. The study contributes to international finance by demonstrating how ambiguous or inconsistent climate policy communication can destabilize currency markets, offering insights for central banks, regulators, and investors seeking to manage risks in the low-carbon transition.