Geopolitical risk spillovers and its determinants

Geopolitical risk (GPR) tends to cascade from one country to another. Understanding GPR transmission is important to devising risk management strategies for institutional investors and corporate managers, and national security policies for governments. In this paper, we measure and explain cross-country transmission of GPR. Our sample covers 19 country-based GPR indexes of Caldara and Iacoviello (Measuring geopolitical risk, 2018) from January 1985 to December 2016. We apply the spillover model of Diebold and Yilmaz (Int J Forecast 28:57–66, 2012) to measure pairwise as well as system-wide GPR transmission. The estimation results show a substantial amount of GPR transmission across our sample countries, with certain countries and geographical clusters being more prominent than others. We then explain the pairwise GPR transmission using a cross-sectional regression motivated by a gravity model framework. We find that certain bilateral linkages such as bilateral trade and geographical proximity significantly explain the pairwise GPR transmission. This transmission is positively associated with both countries’ debt burdens and geographical sizes, transmitting country’s fiscal imbalance, and is negatively associated with recipient country’s economic size. The results imply that these factors may be used to predict the trajectory of GPR, which is an important input for the assessment of cross-border investment appraisals as well as international stability initiatives.