The Neuroscience of Risk Perception in Financial Markets: How Climate Policy Uncertainty Affects Investor Cognition...

Climate related risks are increasingly affecting financial markets, most importantly, policy risk regarding climate regulation. Not only do such risks impact market dynamics, but they can also have an impact on investor behaviour as cognitive and emotional reactions to risk. Understanding the interplay between climate policy and market volatility is essential for both economic forecasting and behavioural finance.

This study aims to examine the dynamic relationship between climate policy uncertainty and the volatility of major stock market indices viz. Nifty 50 and Sensex in India, and Nasdaq and Dow Jones in the USA and exploring potential neurobehavioural responses of investors to such uncertainty.

This research aims to determine the dynamic relationship between climate policy uncertainty, Indian benchmark indices Nifty 50 and Sensex, and USA stock market indices Nasdaq and Dow Jones for the monthly data from 1st April 2010 to 31st March 2024. The article has adopted Diebold and Yilmaz's connectedness framework and WC approach for data analysis. The analysis is interpreted through the lens of neuroeconomics, considering how climate policy uncertainty may influence cognitive risk processing in financial decision-making.

Findings show that indices such as Sensex, Nasdaq and Dow Jones are more responsive to climate policy uncertainty compared with others. These trends suggest that the reactions of global investors are not only strategic but also subject to psychological tension and risk perception mechanisms.

Uncertainty in climate policy exerts a notable influence on stock market volatility with far-reaching implications extending beyond the classical economic indicators to encompass investor cognition and neurobehavioural reactions. The outcome of the current research underscores incorporating neuroscience-informed methods into financial decision-making, providing significant feedback for investors and policymakers regarding risk management, portfolio maximisation and interpreting behavioural responses under environmental uncertainty.