Geopolitical risks and investor sentiment: Causality and TVP-VAR analysis

Abstract

This paper aims to explore the relationship between geopolitical risks (GPR) and investor sentiment in the US stock market based on Granger causality test and time-varying parameter vector autoregression (TVP-VAR) analysis. Empirical results indicate that changes in geopolitical risks can affect investor sentiment, whereas investor sentiment cannot affect geopolitical risks. More importantly, geopolitical risks have significant negative effects on investor sentiment, suggesting that higher (lower) geopolitical risks dampen (promote) investor sentiment directly or indirectly. Specifically, the negative effects of geopolitical risks show substantial time variation and generally decrease over time. The response of investor sentiment appears to be more pronounced in the short and medium term than in the long term, and is more sensitive to domestic geopolitical events. There is no significant difference in the impacts of geopolitical risks (GPR), geopolitical threats (GPT), and geopolitical acts (GPA). The results obtained are robust for alternative investor sentiment and geopolitical risk indicators.