The Impact Of Geopolitical Risk On The Stock Price

Geopolitical risk has become one of the most urgent risk of world economy.Entrepreneurs,investors and government regulators raised their concerns about the adverse impact of the geopolitical risk having on them.In order to assess the geopolitical risk and its economic influences,Caldara and Iacoviello(2018)constructed geopolitical risk index based on the frequencies of newspaper articles covering the geopolitical risk in the U.S.A.Beyond that,Black Rock,the world's largest asset manager,build a global geopolitical risk index.Several studies investigate how the geopolitical risk influences business cycle,precious metal price,corporate investment,corporate cash holding.Our analysis contributes to the literature on the impact of the geopolitical risk have on the stock price through a large sample of firms from 40 stock markets,both developed and emerging.We first construct a novel indicator of the geopolitical risk although various empirical literatures have adopted the geopolitical risk index of Caldara and Iacoviello(2019).The main reason is that the geopolitical risk is derived from the geopolitical tensions among countries,so we argue that studying the relation between the geopolitical risk and stock returns in the international settings is more reasonable.To this end,we build up an indicator that can describe the geopolitical risk of these 40 countries and districts.Following Caldara and Iacoviello(2019),we use the share of articles related to the geopolitical risk in newspapers to proxy the geopolitical risk.What is different from their geopolitical risk index is that we use a database named Access World News rather than 11 leading English newspapers.Secondly,this paper investigates the relation between the geopolitical risk and the crosssection of stock returns in an international setting.We estimate the exposures of individual stocks to the geopolitical risk index,and we find that the geopolitical risk beta has predictive power to the future stock returns through both the portfolio analysis and stock-level crosssectional regressions.These results imply that stocks with the lowest geopolitical risk beta generate 9.324% more annualized return than stocks with the highest geopolitical risk beta.Our results are consistent with the theoretical prediction of Merton's(1973)intertemporal capital asset pricing model that investors command for higher returns to hold stocks with negative geopolitical risk beta and accept lower returns for stocks with positive geopolitical risk beta.Thirdly,this paper studies the impact of the geopolitical risk on stock return volatility(corporate risk-taking).We take the volatility of stock returns as the proxy of corporate risktaking and find that firms lower their levels of risk-taking with the increase in the geopolitical risk.Further results show that for firms with higher financial risk,this effect is more pronounced.What's more,different religious cultures will also shape the effect of the geopolitical risk on the corporate risk-taking.Specifically,for the Protestant and Buddhist background,the levels of corporate risk-taking is reduced more than the other religion background.But for the Islam countries,the levels of corporate risk-taking is barely reduced.Fourthly,this paper examines the impact of the geopolitical risk on stock price crash risk and show that stock price crash risk is positively correlated with the geopolitical risk.To determine whether bad news hoarding is the economic channel through which the geopolitical risk increases future crash risk,we perform the channel test using a two-step regression approach following Kim et al.(2016).In the first step,we examine the association between anti-corruption and bad news hoarding.In the second step,we examine the association between bad news hoarding and future crash risk.Consistent with the theoretical prediction that the geopolitical risk reduces future crash risk through curtailing bad news hoarding,we find that the geopolitical risk is positively associated with bad news hoarding in the first step regression while bad news hoarding is positively associated with future crash risk in the second step regression.Further study shows that the effect of geopolitical risk on crash risk is weaker in countries with higher government efficiency and better information environment.We make two key contributions to the literature.First,we construct a novel indicator of the geopolitical risk for 40 countries(districts).Second,this paper is the first one to empirically examine the relation between the geopolitical risk and stock price in an international setting.We also make some practical suggestions for enterprises and financial supervision.Because we provide several approaches for measuring and monitoring geopolitical risk.Moreover,we provide evidence that government efficiency and country information environment can help improve the quality of financial statement,and then restrict bad news hoarding behavior of corporate management.This is of great importance for firms to adjust corporate policy and for financial supervision to stable the financial market while the geopolitical risk is high.