Climate Stress and Capital Flow Instability: How Environmental Shocks Reshape International Investment Patterns

Abstract

Environmental shocks are increasingly recognized as a driver of instability in international capital markets, yet the precise ways in which climate-related events translate into extreme movements of cross-border investment remain underexplored. This paper offers a conceptual framework that traces how climate disturbances propagate through financial channels and generate episodes of capital surge, sudden contraction, resident flight, and foreign withdrawal. Four distinct pathways are elaborated. The first concerns how climate uncertainty leads investors to defer long-term commitments. The second focuses on how disaster-induced fiscal strain weakens sovereign credit and provokes portfolio liquidation. The third examines the redirection of investment toward jurisdictions perceived as climatically secure. The fourth addresses how the low-carbon transition reshapes sectoral capital allocation across borders. These pathways are then integrated into a classification that links specific climate triggers to expected flow outcomes and their reversibility. Several recent episodes serve as illustrations. The paper closes with policy implications and suggestions for empirical testing.