Introduction Construction Understanding Effects Robustness Conclusions Appendix
Measuring Geopolitical Risk
Dario Caldara Matteo Iacoviello
Federal Reserve Board
North Carolina State University February 22, 2018
Disclaimer: The views expressed are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Geopolitical Risks Receive a Lot of Attention...
Geopolitical risks often cited by policy-makers, investors, and media as key determinants of economic decisions. 2017 Gallup Survey: 75 % of investors worried about geopolitical risk for business environment. Geopolitical Risk part of ‘uncertainty trinity’ that could have significant adverse economic effects. Carney (2016) Geopolitical Risk salient risk to outlook (IMF 2017, ECB 2017, WB 2018) Introduction Construction Understanding Effects Robustness Conclusions Appendix
...but their Consequences are Unclear
Little research devoted to quantify the macroeconomic and financial impact of geopolitical risks. Introduction Construction Understanding Effects Robustness Conclusions Appendix
What We Do
1. Construct an indicator of geopolitical risk—GPR Index—measuring frequency of articles in leading newspapers discussing rising geopolitical tensions.
I Focus on risks associated with wars, terrorism, tensions between states;
2. High GPR induces:
I adverse effects on US employment, IP, and trade;
I drop in US stock market: heterogeneous response across industries;
I decline in real activity and stock prices in advanced economies;
I capital outflows from emerging economies to safe havens.
3. Economic impact of GPR mostly driven by threat of adverse geopolitical events rather than their realization. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Why We Do It
Existing indicators not amenable to empirical analysis:
I No definition or unclear definition of geopolitical risk;
I Constructed judgmentally with unknown criteria;
I Little variation or short sample availability; Examples
I Constructed as combinations of outcome variables (gold, VIX, dollar, oil prices).
Complement research on effects of wars and terrorist attacks. Blomberg & al (2004); Tavares (2004); Glick & Taylor (2010)
Relationship to proxies for macroeconomic uncertainty:
I Exogeneity of GPR index; Ludvigson & al (2015); Caldara & al (2016)
I Control for effects of realization of events. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Plan of the Talk
Construction of the GPR Index
Understanding the GPR Index
Domestic and International Effects of Higher GPR
Robustness
Conclusions Introduction Construction Understanding Effects Robustness Conclusions Appendix
CONSTRUCTION OF THE INDEX Introduction Construction Understanding Effects Robustness Conclusions Appendix
Definition: Geopolitics and Geopolitical Risk
Geopolitics is a word that encompasses multiple definitions.
We define Geopolitical Risk as the “risk associated with wars, terrorist acts, and tensions between states that affect the normal and peaceful course of international relations.”
Geopolitical risk captures both risk that these events materialize and new risks associated with escalation of existing events. Definition excludes some “geopolitical” phenomena:
I Major economic crisis (e.g. GFC, Eurozone debt crisis)
I Major democratic political events (e.g. Brexit)
I Climate change, civil right movements... Introduction Construction Understanding Effects Robustness Conclusions Appendix
Measurement: Newspaper Searches
Our methodology mimics what Baker, Bloom, Davis (2016) do for EPU Index. The geopolitical risk (GPR) index measures the frequency of articles in 11 newspapers mentioning rising geopolitical tensions. Benchmark index (from 1985):
I United States: Boston Globe; Chicago Tribune; Los Angeles Times; NYT; WSJ; WaPo.
I United Kingdom: Daily Telegraph; FT; Guardian; Times.
I Canada: The Globe and Mail.
Historical index (from 1899): NYT, Chicago Tribune, and WaPo Risks as covered/perceived by the English-speaking press. More weight to events with U.S. involvement. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Not as Simple as Searching for ’Geopolitical’ AND ’Risks’
Language has changed:
I Term ”Geopolitical risk” popular after 9/11
I ”War risks” used to be ”War perils”
I ”Terror Threats” used to be ”Terrorist Menaces”
News articles content has changed:
I Focus shifted from ’chronicles’ to ’opinions’.
Nature of risks has changed:
I From wars to nuclear threats to terrorism. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Measurement: Selection of Search Terms
We define6 search groups based on pilot audit of articles likely mentioning geopolitical risks.
Audit set of articles (E) containing Geopolitics or War or Military or Terrorism/t – most RECURRING WORDS in geopolitics books.
In 2,500 articles in E, about 50% discuss high geopolitical risk (E 1).
Most articles in E 1 contain additional words related to risks or threats, tensions between states, beginning of wars.
Construct search categories based on content of articles in E 1. Exclude from searches phrases overwhelmingly associated with false positives (E 0):
I E.g. movies, anniversaries, obituaries, end of the war. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Measurement: The Search Terms
Search Category Words 1. Geopolitical Geopolitical AND (risk* OR concern* OR tension* OR uncertaint*) Threats ”United States” AND tensions AND (military OR war OR geopolitical OR coup OR guerrilla OR warfare) AND (”Latin America” OR ”Central America” OR ”South America” OR Europe OR Africa OR ”Middle East” OR ”Far East” OR Asia)
2. Nuclear (”nuclear war” OR ”atomic war” OR ”nuclear conflict” OR ”atomic conflict” OR Threats ”nuclear missile*”) AND (fear* OR threat* OR risk* OR peril* OR menace*) ”war risk*” OR ”risk* of war” OR ”fear of war” OR ”war fear*” OR ”military 3. War Threats threat*” OR ”war threat*” OR ”threat of war”
(”military action” OR ”military operation” OR ”military force”) AND (risk* OR threat*)
”terrorist threat” OR ”terrorist threats” OR ”menace of terrorism” OR ”terrorism 4. Terrorist menace” OR ”threat of terrorism” OR ”terrorist risk” OR ”terror risk” OR ”risk Threats of terrorism” OR ”terror threat” OR ”terror threats”
5. War Acts (beginning OR outbreak OR onset OR escalation OR start) ”of the war” (war OR military) AND (”air strike” OR ”heavy casualties”)
6. Terrorist Acts ”terrorist act” OR ”terrorist acts” Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Benchmark Geopolitical Risk Index
GPR Benchmark Index (GPR) Index (2000-2009 = 100) 600
500 Iraq ISIS TWA Hijacking Gulf War invasion Iran/Nuclear Escalation Paris 400 US bombs 9/11 Tensions Libya Iraq Disarmament Madrid Russia annexes attacks Kuwait Crisis 1998 bombings Crimea North 300 Invasion London Syrian Civil War Korea US Invasion bombings Escalation of Panama Arab Spring: 200 Syrian & Lybian War 100
0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
GPR Index updated monthly and available at https://www2.bc.edu/matteo-iacoviello/gpr.htm Introduction Construction Understanding Effects Robustness Conclusions Appendix
Geopolitical Threats vs. Geopolitical Acts
GPR index captures a convolution of shocks to first and higher order moments of the distribution of geopolitical events.
I Spikes in risk often coincide with realization of big events.
We organize searches to separate threats that do not immediately materialize from acts that reveal an underlying threat.
I Geopolitical Threats (GPT): Search categories 1 to 4;
I Geopolitical Acts (GPA): Search categories 5 to 6. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Geopolitical Threats vs Geopolitical Acts Correlation coefficient: 0.60
GPR THREATS AND ACTS Index (2000-2009 = 100) 600 GPR Threats GPR Acts 500 Iraq ISIS TWA Hijacking Gulf War invasion Iran/Nuclear Escalation 400 US bombs 9/11 Tensions Libya Iraq Disarmament Madrid Russia annexes Kuwait Crisis 1998 bombings Crimea Paris 300 Invasion London Syrian Civil War attacks US Invasion bombings Escalation of Panama Arab Spring: 200 Syrian & Lybian War 100
0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Geopolitical Threats vs Acts in 1991 and 2003
Gulf War Iraq Invasion 400 600 GPR Threats GPR Threats GPR Acts GPR Acts 500 300 400
200 300
200 100 100
0 0 1990 1991 2002 2003 Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Historical Geopolitical Risk Index
GPR Historical Index (2000-2009 = 100) 700 WW1 Begins 600 US Joins WW1
Beginning of WWII 500 Iraq Invasion
Attack on Pearl Harbor 400 Gulf War 9/11
Falklands War Begins 300 US Bombing of Libya Russia annexes Crimea Able Archer 83
200 Grain Embargo against USSR Beginning of Russian-Japanese War US Bombing of Iraq Yom Kippur War Italian Invasion of Ethiopia Soviet Union Resumes Nuclear Tests Vietnam War: First Battle of Quang Tri Middle East Tensions pre-6 Day War Hitler threatens Czechoslovakia Suez Crisis Escalation of Korean War First Balkan War Begins Second Boer War and Boxer Rebellion Japan attacks Shanghai and Nanking
Second Taiwan Strait Crisis 100
0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Audit: Reading and Manually Coding Articles
Pilot Audit: Sample 2,500 articles from set E consisting of articles containing: geopolitics, war, military, terrorism/t. 1 0 I Goals: inform and refine search terms; understand true E and false E positives; build audit guide
Full scale Audit: Sample of 6,125 articles (50 per quarter) from E. 1 I Goal: construction of “human GPR”=E /U; I Correlation between GPR index and “Human GPR”: 84%.
Ex post Evaluation: Sample of 2,500 articles only from set selected by automated searches.
I 87% mention high or rising geopolitical tensions. I 4% mention low or decreasing geopolitical tensions. I Correlation between GPR and audited-GPR is 0.98 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Human vs GPR Index
600 GPR Index 500 Human Index
400
300
200
100
0 1985 1990 1995 2000 2005 2010 2015 Introduction Construction Understanding Effects Robustness Conclusions Appendix
UNDERSTANDING THE GPR INDEX Introduction Construction Understanding Effects Robustness Conclusions Appendix
Risks Captured by our Index
Our index captures geopolitical risks as perceived and chronicled by the press in English-speaking countries, particularly in the United States.
The behavior of the index over time shows how different events move the balance of risks over long horizons and at daily frequencies
The index by definition captures media attention towards geopolitical risks, but appears exogenous to major newsworthy events of non-geopolitical nature Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Historical Geopolitical Risk Index: Components
Words in the Historical Index
600 Geopolitical Threats Nuclear Threats War Threats War Acts 500 Terrorist Threats Terrorist Acts
400
300
200 Historical Index (2000-2009=100) Index Historical 100
0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Daily GPR Index
1985 A1985/06/17: TWA Hijacking A1986/04/16: U.S. Bombing of Libya 1987 A1987/04/17U.S-Russia negotiations over nuclear weapons A1987/10/20: War Threats in Persian Gulf 1989 A1989/12/21: U.S. Invades Panama A1990/08/04: Iraq Invades Kuwait 1991 A1991/01/15 : Gulf War. Operation Desert Storm
1993 A1993/01/14 : Air Strikes against Iraq A1993/06/28: U.S. Raid on Baghdad
1995
A1996/09/04 : U.S. Raid on Iraq 1997 A1998/02/18: Clinton Makes Case for Strike Against Iraq 1999 A1998/12/17: Iraq Disarmament Crisis Escalation A1999/12/25 : Holidays' Terrorist Concerns 2001 2001/09/12 : 9/11 Terrorist Attacks A2001/10/08 : U.S. invades Afghanistan A2002/09/25: War Fears U.S. / Iraq 2003 A2003/03/19: Beginning of the Iraq War A2004/03/23: Assassination of Sheik Yassin, Middle East Tensions 2005 A2004/08/03: Terrorist threats in New York and Washington A2005/07/08: London Bombings 7/7 A2006/08/11: Transatlantic Aircraft Plot 2007 A2007/05/01: War and Terrorism Concerns, Protests in Turkey
A2008/08/12: South Ossetian War Escalation 2009 A2009/12/29 : Flight 253 Failed Bombing Attempt
2011 A2011/05/03: U.S. Announces Death of Osama Bin Laden
2013 A2013/08/28 : Escalation of Syrian Crisis A2014/03/04: Russia invades Crimea A2014/09/02 : Escalation Ukraine/Russia 2015 A2015/11/17: Paris Terrorist Attacks A2016/07/16: Turkish Coup Attempt 2017 A2016/07/07: Middle East Concerns; Chilcot Report Released A2017/08/10: Escalation of Tensions Between U.S. and North Korea
0 200 400 600 800 1000 1200 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Daily GPR Index Figure A.12: Newspapers’ front pages on days of heightened geopolitical risk
(a) January 7, 1991 (b) January 17, 1991
.
(c) September 12, 2001 (d) October 3, 2001
.
(e) August 10, 2017 (f) August 23, 2017
A.17 Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and Natural Disasters
800 GPR Natural Disasters Index
600 Hurricane Katrina Hurricane
400 Tsunami Ocean Indian
California Wildfires California
Loma Prieta Earthquake Prieta Loma
Tohoku Earthquake Tohoku Northridge Earthquake Northridge
200 Indexes: 2000-2009 = 100 = 2000-2009 Indexes:
0 1985 1990 1995 2000 2005 2010 2015
GPR Index is not correlated with changes in media coverage of unpredictable newsworthy events. → No difference between objective geopolitical risks and media attention towards them Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and Sport Events
600 GPR 500 Sport Events Index
400
300
200
100 Indexes: 2000-2009 = 100 = 2000-2009 Indexes:
0 1985 1990 1995 2000 2005 2010 2015
GPR Index is not correlated with changes in media coverage of predictable newsworthy events. Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and Newspaper Slant
600 GPR Left-Leaning Newspapers 500 GPR Right-Leaning Newspapers
400
300
200
100 Indexes: 2000-2009 = 100 = 2000-2009 Indexes:
0 1985 1990 1995 2000 2005 2010 2015
GPR Index does not reflect newspaper political slant. Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and ICB Database
400 GPRH ICB: Number of International Crisis 10 300 8
200 6
4 Count Crisis 100
2 Historical Index (2000-2009=100) Index Historical 0 0 1900 1920 1940 1960 1980 2000
GPR displays more high-frequency variation, allowing to establish the importance of GPR for stock returns over relatively short samples. Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and War Deaths
600 7000 GPR 500 Total Deaths due to war and terror (right scale) 6000 Civilian Deaths due to terrorism, US & Europe (right scale) 5000 400 4000 300
3000 Deaths 200 2000
100 1000 GPR Index (2000-2009=100) Index GPR
0 0 1985 1990 1995 2000 2005 2010 2015 Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR and EPU GPR vs EPU EPU GPR Iraq 250 Debt Ceiling Debate Fiscal Cliff 600 invasion Govt. US bombs Euro Crisis Shutdown Libya Gulf War Lehman Failure 500 Kuwait Russia Madrid and TARP 200 Invasion 9/11 annexes bombings Crimea Bush Election Stimulus Debate 400 Ukraine Black Russian Crisis/LTCM Transatlantic and ISIS Monday aircraft plot Paris 150 Clinton Election 300 attacks London bombings 200 100 100
50 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
GPR vs VIX 2002 VIX correction GPR 90 Kuwait Asian 9/11 600 Invasion Financial Iraq Lehman Euro 80 Black Crisis LTCM invasion crisis Monday 500 70
60 400
50 300 40
30 200
20 100 10
0 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 GPR vs EPU EPU GPR Iraq 250 Debt Ceiling Debate Fiscal Cliff 600 invasion Govt. US bombs Euro Crisis Shutdown Libya Gulf War Lehman Failure 500 Kuwait Russia Madrid and TARP 200 Invasion 9/11 annexes bombings Crimea Bush Election Stimulus Debate 400 Ukraine Black Russian Crisis/LTCM Transatlantic and ISIS Monday aircraft plot Paris Introduction150 Construction Clinton ElectionUnderstanding Effects Robustness Conclusions Appendix 300 attacks London bombings 200 GPR100 and VIX 100
50 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
GPR vs VIX 2002 VIX correction GPR 90 Kuwait Asian 9/11 600 Invasion Financial Iraq Lehman Euro 80 Black Crisis LTCM invasion crisis Monday 500 70
60 400
50 300 40
30 200
20 100 10
0 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Introduction Construction Understanding Effects Robustness Conclusions Appendix
EFFECTS OF HIGHER GPR Introduction Construction Understanding Effects Robustness Conclusions Appendix
Economic Effects of GPR
How could GPR matter?
1. Standard Uncertainty/Macro Channels.
2. Effects on Stock Returns.
3. Effects on Capital Flows. Uncertainty could reshuffle portfolios towards safe havens. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Effects of Higher GPR: A VAR Analysis
Sample: 1985M1 to 2016M12. US benchmark VAR: 1. GPR Index; 2. Economic Policy Uncertainty (EPU); 3. Consumer sentiment; 4. US industrial production; 5. Private payroll employment; 6. US Imports + Exports; 7. Value-weighted S&P 500 Index; 8. Oil price; 9. Yield on 2-Year Treasury.
Extra variable: Industries Excess Return over S&P 500. Identification: GPR Index ordered 1st in Cholesky ordering. Shock sized to match typical increase in GPR after major events Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Macroeconomic Impact of Increased GPR
GPR Index EPU Index Consumer Sentiment 30 10 150 20 5 100
10 (%) 50 0 0 0 -5 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Employment Gross Trade 0.5 2 0 0 0
-0.5
(%) (%) (%) -1 -0.5 -2 -1.5 -4 -2 -1 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
S&P500 Real Oil Price 2-Year Treas. Yield 5 5 40
0 20 -5
0 0
(%) (%)
-10 (BPS) -15 -20 -5 -20 -40 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Increased Geopolitical Risk and Stock Returns Cumulative Excess Return Over S&P 500 - Selected Industries
Defense Oil Aircraft 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Steel Works Mining Insurance 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Effects of Higher GPR: Acts vs Threats
Modify VAR used to study effects of GPR on US economy.
Replace GPR with GPA and GPT.
Identification: GPA ordered 1st and GPT 2nd in Cholesky ordering.
I GPA shocks move GPT on impact.
I GPT shocks do not move GPA on impact.
GPA shocks convolution of shocks to first and higher moments of geopolitical events distribution.
GPT shocks primarily shocks to uncertainty and risk. Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Impact of Increased GPR: Acts Selected Variables from US VAR
GPA (Acts) Index GPT (Threats) Index EPU Index 300 30
150 20
200 100 10 0 50 100 -10 0 -20 0 -50 -30 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Gross Trade S&P500 5 6 1 4 0 2
0
(%) (%) (%) 0 -1 -2 -2 -4 -5 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Impact of Increased GPR: Threats Selected Variables from US VAR
GPA (Acts) Index GPT (Threats) Index EPU Index 300 30
150 20
200 100 10 0 50 100 -10 0 -20 0 -50 -30 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Gross Trade S&P500 5 6 1 4 0 2
0
(%) (%) (%) 0 -1 -2 -2 -4 -5 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Impact of Increased GPR: Acts Cumulative Excess Return Over S&P 500
Defense Oil Aircraft 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Steel Works Mining Insurance 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
The Impact of Increased GPR: Threats Cumulative Excess Return Over S&P 500
Defense Oil Aircraft 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Steel Works Mining Insurance 15 15 15
10 10 10
5 5 5
(%) (%) (%) 0 0 0
-5 -5 -5
-10 -10 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
International Effects of Higher GPR
Three models chosen depending on data availability and timing of effects. 1. International Macro Impact: VARs (dynamic effects):
I GPR Index; I EPU; I Country/Region ’X’ industrial production.
2. Stock Returns: Univariate regressions
ri,t = µi + αi GPRSHOCKt + εi,t ,
(monthly data from pre-WWII)
3. Capital Flows y: Panel regressions
yi,t = αi + ρ1yi,t−1 + βGPRt + ΓXt + ui,t , Introduction Construction Understanding Effects Robustness Conclusions Appendix
1. The International Impact of Increased GPR Industrial Production for Selected Countries and Regions
World Advanced Economies Emerging Economies 2 2 2
1 1 1
0 0 0
(%) (%) (%)
-1 -1 -1
-2 -2 -2
0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Canada United Kingdom Mexico 2 2 2
1 1 1
0 0 0
(%) (%) (%)
-1 -1 -1
-2 -2 -2
0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
2. Geopolitical Risk and Stock Returns
Table 2: GPR and World Stock Market Returns
Country GPR Historical GPR Benchmark (1) (2) (3) (4) GPR -0.45 -0.74 0.31 (0.27) (0.35) Crisis Index -0.16 -0.16 0.24 0.23 (0.15) (0.15) (0.34) (0.34) GPA -0.10 0.35 (0.30) (0.23) GPT -0.31 -0.99 (0.22) (0.36)
Note: Estimation of the effect of geopolitical risk on world stock market returns between 1919 and 2016. We standardize the GPR, GPA and GPT indexes so that the coefficient measures the percent change in stock returns to a 1 standard deviation innovation in a given index. The variable crisis is the total number of crises in a month, normalized by 2.41, the average number of active crisis in our sample. Standard errors reported in parentheses are corrected for autocorrelation using the Newey-West method. See Section 5.2 for additional details. Source: Global Financial Data and International Crisis Database.
32 Introduction Construction Understanding Effects Robustness Conclusions Appendix
2. Geopolitical Risk and Stock Returns: Countries
Table 3: GPR and Country Stock Market Returns
Country GPR Historical GPR Benchmark (1) (2) (3) (4) (5) Coefficient Std. Errors Sample Start Coefficient Std. Errors Australia -0.30 (0.22) 1900 -0.25 (0.30) Belgium -0.70 (0.31) 1900 -1.32 (0.42) Canada -0.62 (0.23) 1914 -0.64 (0.25) Finland -0.20 (0.36) 1923 -0.45 (0.58) France -0.59 (0.33) 1900 -1.18 (0.53) Germany -0.09 (0.62) 1918 -1.44 (0.64) India -0.49 (0.50) 1922 -0.67 (0.58) Italy -0.90 (0.38) 1905 -1.50 (0.55) Japan 0.07 (0.32) 1914 -0.34 (0.35) Netherlands -0.30 (0.37) 1919 -1.28 (0.50) Peru -0.59 (0.71) 1933 -1.05 (0.96) Portugal -0.27 (0.52) 1934 -0.95 (0.43) Spain -0.27 (0.32) 1915 -0.83 (0.49) South Africa -0.84 (0.23) 1910 -1.33 (0.32) Sweden -0.40 (0.28) 1906 -0.83 (0.53) United Kingdom -0.56 (0.23) 1900 -0.96 (0.37) United States -0.43 (0.29) 1900 -0.78 (0.35)
Note: Estimation of the effect of geopolitical risk on individual countries’ stock market returns. We standardize the GPR index so that the coefficient measures the percent change in stock returns to a 1 standard deviation innovation in a given index. Column (3) reports the year in which the monthly data on stock returns are available for each country, while the sample ends in 2016 for all countries. Standard errors reported in parenthesis are corrected for autocorrelation using the Newey-West method. See Section 5.2 for additional details. Source: Global Financial Data.
33 Introduction Construction Understanding Effects Robustness Conclusions Appendix
3. Geopolitical Risk and Capital Flows
Table 4: GPR and Capital Flows
(1) (2) (3) Inflows/GDP Inflows/GDP Inflows/GDP Variables Emerging Economies Advanced Economies United States
Lagged Inflows 0.30 0.16 0.51 (0.06) (0.06) (0.08)
GPR Index, standardized -0.23 1.00 0.44 (0.12) (0.32) (0.36)
VIX, standardized -1.09 -1.54 -0.88 (0.18) (0.59) (0.37)
Lagged GDP Growth 0.29 1.61 0.01 (0.09) (0.36) (0.62)
Observations 1,932 2,305 119 R-squared 0.170 0.047 0.329 Number of countries 23 22 1 Country Fixed Effects YES YES — Clustered Standard Errors YES YES —
Note: Estimation of effects of geopolitical risk on gross capital inflows. We standardize both the GPR index and the VIX, so that the coefficients report the response of the ratio of inflows to gdp (in percentage points) to a 1 standard deviation innovation in GPR and the VIX. Robust standard errors reported in parenthesis. See Section 5.3 for additional details. Source: IMF’s Balance of Payments Statistics database.
34 Introduction Construction Understanding Effects Robustness Conclusions Appendix
ROBUSTNESS Introduction Construction Understanding Effects Robustness Conclusions Appendix
Robustness Analysis
Investigate the following modifications to the baseline VAR specification: 1. Censored GPR index: Keep only 9 largest peaks. 2. Dummy for 9/11. 3. Alternative Cholesky ordering
4. Replace EPU with the VIX.
Alternative specifications of GPR index: 1. Broader and narrower list of search terms; 2. Exclude articles mentioning economic consquences of GPR. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Censoring + 9/11 Dummy
GPR Index EPU Index Consumer Sentiment 30 10 150 20 5 100
10 (%) 50 0 0 0 -5 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Employment Gross Trade 0.5 2 0 0 0
-0.5
(%) (%) (%) -1 -0.5 -2 -1.5 -4 -2 -1 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
S&P500 Real Oil Price 2-Year Treas. Yield 5 5 40
0 20 -5
0 0
(%) (%)
-10 (BPS) -15 -20 -5 -20 -40 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Baseline 9/11 Dummy Censored GPR Introduction Construction Understanding Effects Robustness Conclusions Appendix
Ordering GPR Last
GPR Index EPU Index Consumer Sentiment 30 10 150 20 5
100 10 (%) 50 0 0 -10 0 -5 -20 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Employment Gross Trade 0.5 1 2
0 0
0
(%) (%) (%) -2 -1 -0.5 -4 -2 -1 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
S&P500 Real Oil Price 2-Year Treas. Yield 10 5 40 0 5 20 -5
0 (%) (%) 0 -10 (BPS) -15 -20 -5 -20 -40 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Replacing EPU with the VIX
GPR Index VIX Consumer Sentiment 30 10 150 20 5 100
10 (%) 50 0 0 0 -5 -10 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
Industrial Production Employment Gross Trade 0.5 1 2
0 0
0
(%) (%) (%) -2 -1 -0.5 -4 -2 -1 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24
S&P500 Real Oil Price 2-Year Treas. Yield 5 40 5 0 20 -5
0 0
(%) (%)
-10 (BPS) -15 -20 -5 -20 -40 0 6 12 18 24 0 6 12 18 24 0 6 12 18 24 Introduction Construction Understanding Effects Robustness Conclusions Appendix
Conclusions
We construct a quantitative measure of geopolitical risk.
For many countries, the GPR index is perhaps more ”exogenous” to economic conditions than other uncertainty measures.
Geopolitical risk has adverse effects on real activity and stock returns in advanced economies.
The effect on US stock returns varies across industries.
Adverse effects of geopolitical risk are mostly driven by the threat of adverse geopolitical events.
We are currently working on constructing country-specific GPR indexes. Introduction Construction Understanding Effects Robustness Conclusions Appendix
Available Indices 1: Doomsday Clock Introduction Construction Understanding Effects Robustness Conclusions Appendix
Available Indices 2: Geopolitical Heat Maps
Back Introduction Construction Understanding Effects Robustness Conclusions Appendix
Most Frequent Words in Geopolitics Textbook
1200
1000
800
600
400
200
0
war unit
polit
state code
world terror
global
nation power
leader
countri
conflict
geopolit boundari
Back Introduction Construction Understanding Effects Robustness Conclusions Appendix
Content of Articles in Pilot Auditing
Scatter plot of the 4 principal components from analysis of the top 50 bigrams from 2,500 newspaper abstracts classified as E 1.
Back Introduction Construction Understanding Effects Robustness Conclusions Appendix
Frequent Unigrams in Flint’s Geopolitics Textbook
1200
1000
800
600
400
200
0
war unit
polit
state code
world terror
global
nation power
leader
countri
conflict
geopolit boundari
Back Introduction Construction Understanding Effects Robustness Conclusions Appendix
Increased Geopolitical Risk and Investment Nonresidential Investment and Consumer Durables
Estimation of quarterly VAR from 1985 to 2016.
GPR Shock GPA Shock GPT Shock 2 2 2
1 1 1
0 0 0
-1 -1 -1
(%) (%) (%) -2 -2 -2
-3 -3 -3
-4 -4 -4
-5 -5 -5 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 Quarters Quarters Quarters Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR Index for China
GPR-CHINA 900
800
700 Tiananmen Sq. Massacre Sq. Tiananmen 600 Protests Sq. Tiananmen
500
400
300 Incident Island Hainan Missile Testing Missile
200 "9/11"
100
0 1985 1990 1995 2000 2005 2010 2015
“China AND (tensions/risk*/fear/chaos/uncertainty/unrest/violence...) AND (military/war/geopolitical/coup/guerrilla/warfare/army/terrorism)”, scaled by 1-year MA of newspaper articles mentioning China. Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR Index for Korea
GPR-KOREA 800
700
600 June Democracy Movement Democracy June
500
DPRK Nuclear Crisis Nuclear DPRK
Cyber Attack Cyber Tensions Border Escalated
400
Yeonpyeong Island Incident / G20 / Incident Island Yeonpyeong DPRK Nuclear Test Nuclear DPRK
300 858 Air Korea
Team Spirit Ultimatum Spirit Team
Naval Skirmish w/ DPRK w/ Skirmish Naval
Presidential Election Presidential
Inter-Korean Summit 2 Summit Inter-Korean
DPRK Incursion DPRK Border Fire w/ DPRK w/ Fire Border 200
100
0 1985 1990 1995 2000 2005 2010 2015
“Korea AND (tensions/risk*/fear/chaos/uncertainty/unrest/violence...) AND (military/war/geopolitical/coup/guerrilla/warfare/army/terrorism)”, scaled by 1-year MA of newspaper articles mentioning Korea. Introduction Construction Understanding Effects Robustness Conclusions Appendix
GPR Index for Ukraine
GPR-UKRAINE 1800
1600
Ukrainian Revolution Ukrainian Crisis Crimean
1400
1200 Independence of Declaration
1000 Independence Military Announce
800
600
Orange Revolution Orange
Political Crisis Political Crimean Referendum Crimean
400 Statement Trilateral Vrancea Eathquakes Vrancea
200
0 1985 1990 1995 2000 2005 2010 2015
“Ukraine AND (tensions/risk*/fear/chaos/uncertainty/unrest/violence...) AND (military/war/geopolitical/coup/guerrilla/warfare/army/terrorism)”, scaled by 1-year MA of newspaper articles mentioning Ukraine.