Geopolitical Risk and Stock Market Volatility in Emerging Economies: Evidence from GARCH-MIDAS Model

Menglong Yang,Qiang Zhang,Adan Yi,Peng Peng,Baogui Xin

doi:10.1155/2021/1159358

Abstract

Previous studies have found that geopolitical risk (GPR) caused by geopolitical events such as terrorist attacks can affect the movements of asset prices. However, the studies on whether and how these influences can explain and predict the volatility of stock returns in emerging markets are scant and emerging. By using the data from China’s CSI 300 index, we provide some evidence on whether and how the GPR factors can explain and forecast the volatility of stock returns in emerging economies. We employed the GARCH-MIDAS model and the model confidence set (MCS) to investigate the mechanism of GPR’s impact on the China stock market, and we considered the GPR index, geopolitical action index, geopolitical threat index, and different country-specific GPR indices. The empirical results suggest that except for a few emerging economies such as Mexico, Argentina, Russia, India, South Africa, Thailand, Israel, and Ukraine, the global and most of the regional GPR have a significant impact on China’s stock market. This paper provides some evidence for the different effects of GPR from different countries on China’s stock market volatility. As for predictive potential, GPRAct (geopolitical action index) has the best predictive power among all six types of GPR indices. Considering that GPR is usually unanticipated, these findings shed light on the role of the GPR factors in explaining and forecasting the volatility of China’s market returns.

Highlights

As a global phenomenon, geopolitical risk (GPR) has long been considered as a major factor that influences the business cycle and financial markets
We address the above issues by employing the GARCH-MIDAS model with different GPR indices, such as the categorical GPR indices as well as the regional GPR index from 18 different emerging economies, to distinguish the effects of categorical and regional GPR from those of general and global ones
With respect to the categorical GPR indices, we find that compared with GPRAct, GPRTreat generates a stronger and positive impact on the volatility in CSI 300, which indicates that in China, investors are more sensitive to geopolitical threats rather than geopolitical actions

Summary

Introduction

Geopolitical risk (GPR) has long been considered as a major factor that influences the business cycle and financial markets. E explaining and forecasting ability of regional and global GPR is important for China because the financial system of emerging markets is usually subject to their exposure to GPR [4, 8] Against this backdrop, previous literature has built up a preliminary foundation for GPR’s predictive potential for the stock market. It can be seen that even though the regional structure of China’s outbound investment is constantly changing, the GPR is constantly posing a wide range of threats to the China stock market. Under such circumstances, related studies need to pay more attention to the effects of regional GPR and distinguish the differences from those of global ones.

Literature Review

Methodology

Findings

Empirical Analysis