Geopolitical risk and stock market development

Abstract

While previous literature has documented adverse impacts on financial markets in the days following individual acts of terrorism or conflict-related events, we consider the more general, ongoing uncertainty those events contribute to: geopolitical risk (GPR). Using a sample of 37 countries spanning 1975–2019, we provide evidence of a strong, negative relationship between GPR and stock market development. To support our main results we run a series of robustness and endogeneity checks, in the process demonstrating that the impact of GPR is distinct from other macroeconomic risks such as economic policy uncertainty. We also consider several dimensions of heterogeneity among countries that cause the effects of GPR on stock market development to vary, providing more insight into those effects. In particular, we find that GPR’s negative impact is stronger for those in North America and Europe as compared to Asia. We also find that GPR’s effect is stronger for economies with higher levels of investment, which is consistent with our theory of investment as a mechanism for GPR’s influence on stock market development.