Climate change in Europe and international portfolio allocation: Micro-level evidence from global funds

Abstract

This paper investigates the impact of climate change on international portfolio allocations of global funds. We select the heat wave disasters in Europe in 2018 as a quasi-natural experiment and employ the DID framework. Our findings indicate that global funds would reduce their holdings in the affected country after heat wave disasters. The congestion of inland waterways and electricity shortages during the heatwave have resulted in production delays, thereby transmit risks to the financial sector. Countries with higher foreign exposure experience a larger scale of capital outflow after heat waves; while countries with great institutional quality and resilience demonstrate greater capacity to withstand heat wave disasters. The funds with lower risk tolerance are more sensitive to climate change. Additionally, domestic funds will remain in their home countries post-heatwave when foreign capitals flow away. These findings have important policy implications, and countries with high climate risks should carefully monitor the capital flows. In order to reduce the impact of climate risks, it is crucial to improve the quality of institution and efficiency of government as well as to implement effective disaster prevention and mitigation measures.