Gauging geopolitics

A framework to assess and price geopolitical risks

Geopolitical risks are on the rise – and can have meaningful impacts on the global economy, financial markets and investment portfolios. Such impacts are difficult to quantify or to predict. BlackRock has launched an effort to better measure and monitor geopolitical risks and their market impact in a systematic way. We present our framework – and the early conclusions of this ongoing work.

Shock waves

U.S. equity returns after exogenous geopolitical shocks, 1962–2017

Chart: Most companies in the U.S, EU, and U.K. are private chart

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Thomson Reuters Datastream and Bloomberg, June 2019. Notes: The charts focus on 31 "exogenous" (unexpected) geopolitical shock events between October 1962 and January 2019. Examples include terrorist attacks and the Arab Spring. The chart on the left depicts average equity returns following the shocks. We use the S&P 500 as a proxy, given its longer available history than global equity indexes. The chart on the right shows equity returns following the eight shocks that occurred in months when the U.S. economy was contracting (ISM U.S. Manufacturing PMI was below 50). The "Average return" lines are calculated based on the closing price of the S&P 500 Index one day before the event date. One the left hand chart, the average return (all periods) line shows the cumulative average daily return between 1960 and 2019; on the right hand chart, the average return (contraction periods) line shows the cumulative average daily return between 1986 and 2015 when the U.S. PMI was below 50. The shaded gray "range" is the standard error, or standard deviation, of the historical distribution.

A key takeaway from our study of 68 key geopolitical risk events since 1962: The average market response to unexpected geopolitical shocks has historically been relatively modest and short-lived. Equity markets have shown modest losses in the 30 trading days following an “exogenous” (unexpected) geopolitical event, our study of the 31 geopolitical events showed. See the chart on the left.

The negative market reaction has historically been more severe when the economic environment is weak to begin with, our study showed. The average return for all exogenous geopolitical shocks that occurred when the U.S. economy was contracting tended to be of greater magnitude, as the chart on the right shows. This makes analysis of such risks very pertinent in today’s late-cycle economic environment, we believe.

Authors

Catherine Kress
Catherine Kress
Advisor to the Chairman of BlackRock Investment Institute
Carl Patchen
Carl Patchen
Member of BlackRock's Risk and Quantitative Analysis Group
Ron Ratcliffe
Ron Ratcliffe
Head of Multi-Asset Investment Risk – Americas West
Eric Van Nostrand
Eric Van Nostrand
Head of Macro Research and Portfolio Strategy,<br />Multi-Asset Strategies Group
Kemin Yang
Kemin Yang
Multi-asset strategist at BlackRock Investment Institute
  • We illustrate the historical importance of geopolitical risk in markets, based on a study of 68 key events since 1962. These ranged from wars and terror attacks to political events such as elections. Some of our findings are intuitive: The effect of geopolitical shocks on global markets often is modest but tends to be more acute — and potentially long-lasting — in markets closest to the epicenter of the event.
  • We detail our framework for identifying and analyzing geopolitical risk events. Our process draws on experts across BlackRock in risk management, geopolitics, portfolio management and quantitative analytics, and underlies our assessment of the top-10 risks highlighted on our Geopolitical risk dashboard. We illustrate our methodology with a timely risk: Global trade tensions.
  • We explain how our BlackRock Geopolitical Risk Indicators (BGRIs) can help assess to what extent geopolitical risks are priced in. The BGRIs measure the degree of market attention to specific risks relative to their history. The tool scrapes analyst reports as well as traditional and social media for the frequency of key words related to each risk — and the sentiment (positive or negative) associated with it. The higher the BGRI level, the more we assume that risk is priced in. We use this insight to adjust our estimated market shocks for each risk according to its BGRI — and to pinpoint assets especially sensitive to the risk.

Authors

Tom Donilon
Tom Donilon
Chairman of the BlackRock Investment Institute
Ben Golub
Ben Golub
Chief Risk Officer and Co-head of Risk and Quantitative Analysis

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