Are geopolitical threats powerful enough to predict global oil price volatility?

Abstract

Geopolitical risks have been widely linked to oil price movements in the past. Our study as an addition to this debate shows that geopolitical threats particularly play a significant role in the volatility experienced in global oil markets with attendant policy suggestions. In this study, we employed the newly developed geopolitical threats index to examine whether threats of war, terrorism, and ethnic and political violence within and between countries are powerful enough to predict volatility in global oil prices. Monthly data on global geopolitical threats index and global prices of crude were drawn upon for causality between the periods 1990:01 and 2020:04. To this effect, two volatility indices were constructed using the deviations of Brent and WTI prices from their Hodrick-Prescott filters. The ability of the geopolitical threats index to predict volatilities was examined through a battery of causality methodologies-Granger causality test in frequency domain, nonparametric test for nonlinear causality, leveraged bootstrap causality test, and Fourier Toda-Yamamoto causality test. Through various causality methodologies, we were able to ensure robustness against various problems associated with the classical linear Granger causality testing approach and ascertain that geopolitical threats are powerful and useful predictors of volatility in global oil prices.