Extreme weather, climate risk, and the lead–lag role of carbon

Abstract

This study employs the thermal optimal path method to establish a framework for dynamic nonlinear connections between Chinese carbon and foreign exchange markets. Subsequently, it examines the effects of extreme weather events on the lead–lag role played by carbon. The empirical results indicate that China's carbon market typically lags behind its currency exchange market. Compared to the Hubei carbon market, the Guangdong carbon market experiences synchronized price movements between carbon and foreign exchange due to high pricing efficiency. Furthermore, shocks from extreme weather events can attract public attention to the carbon market and cause the typical lead–lag structure to reverse, whereupon the carbon market leads the foreign exchange market under such shocks, especially during heat waves. Our findings have implications for investors aiming for positive cumulative returns on hedging portfolios and policymakers wishing to bolster the financial market's ability to withstand exogenous shocks.