Does Geopolitical Risk Matter? Evidence from South Korea

Abstract

ABSTRACT This study explores the impact of geopolitical events on the stock return behavior of inter-Korean economic cooperation-related firms depending on the North Korean regime. We document empirical evidence showing that cross-sectional stock return tends to react positively to positive geopolitical events under the current regime in North Korea (Kim Jong-un), whereas negative geopolitical events have limited impact. Conversely, we find that negative geopolitical events yielded more pronounced effects on the stock returns of related firms under the former regime (Kim Jong-il). In addition, this study investigates the role of geopolitical shock in the evolution of aggregate economic variables of South Korea using Caldara and Iacoviello’s (2018) geopolitical risk index. Geopolitical shock is found to yield no statistically meaningful impact on stock price index, industrial output, employment, or gross trade volume. Furthermore, aggregate stock market variables are found to be immune to geopolitical shock in South Korea. These results indicate that market participants estimate the escalation of geopolitical risk into full-scale war as unlikely.