Geopolitical risk and global financial cycle: Some forecasting experiments

Abstract

In this study, we investigate the connection between geopolitical risk (GPR) and global financial cycle (GFCy) as well as whether the former has predictive value for the out‐of‐sample predictability of the latter. We utilize both the historical and recent GPR data and their variants, namely, GPR act covering all “acts” that constitute GPR such as war, nuclear invasion and terrorism, and GPR threat, which represents threats of these acts. We construct a predictive model that accommodates the salient features of the predicted and predictor series while the forecast evaluation is conducted for both in‐sample and out‐of‐sample periods. Our findings reveal that a rise in GPR discourages investments in risky assets and by implication worsens GFCy. The impact is more severe after the global financial crisis (gfc), and the GPR threat exerts more adverse effect on GFCy compared with GPR act regardless of whether historical GPR or recent GPR is used. Meanwhile, the predictive model of GFCy that accommodates the GPR data outperforms the benchmark model that ignores it both in the in‐sample and out‐of‐sample estimates albeit with improved forecast performance during the post‐gfc period and at a longer forecast horizon. However, the recent GPR data, which are broader in scope, offer better forecast accuracy than the historical GPR data. Additional analyses involving the vulnerability of global economic conditions reveal similar outcomes as GFCy.

Impact of Geopolitical Risk on G7 Financial Markets: A Comparative Wavelet Analysis between 2014 and 2022

“…Shaik et al (2023) showed that GPR affected stock, gold, and oil returns during the disruptive events of the worldwide economic downturn, COVID-19, and the 2022 Russia-Ukraine war [37]. Salisu et al (2023) emphasized the predictive value of GPR in the global financial cycle (GFCy) [38]. Li et al (2023) found that GPR affects the cost of natural resources, which are necessary for a healthy economy and way of life [39].…”