Exploring a century of global conflicts and their impact on financial assets

The Russia-Ukraine war and recent Middle East conflicts have brought geopolitical tension to the forefront of economic and policy debates, with key institutions like the IMF and the World Bank focusing on how these tensions and risks can affect global trade, financial stability and economic outcomes.

When three Fisher faculty members were curious about how large-scale geopolitical conflicts have historically affected the pricing of financial assets, they came up empty.

Their new working paper, “The Pricing of Geopolitical Tensions over a Century,” aims to fill that gap.

“Our research examines how investor concerns about geopolitical tensions influence the pricing of financial assets,” said Andrei Gonçalves and Alessandro Melone, associate and assistant professors of finance at Ohio State, respectively. They co-authored the paper with Andrea Ricciardi, a graduate research associate in finance.

“The overlapping Russia-Ukraine war and Middle East conflicts provide one of those rare times in 100 years for us to look at the effects of geopolitical tensions on financial assets,” Melone said. “As we began our research, we realized that previous studies largely focused on macroeconomics and economic uncertainty, but not on how geopolitical tensions are priced.”

So, they established three research goals for the paper:

• Understand how geopolitical risks affect investor expectations and behavior.
• Differentiate actual adverse events from threats of future events.
• Provide insights into how geopolitical uncertainty shapes financial asset dynamics.

What makes their research unique is they studied geopolitical risk as two separate categories: geopolitical threats (GPT) and geopolitical acts (GPA). GPT captures expectations of future adverse geopolitical events, such as military buildups and terrorist threats. GPA captures actual realizations of these events.

Their research found geopolitical threats are more relevant for risk perceptions and asset pricing than actual geopolitical acts. The threat of geopolitical unrest affects stock returns and risk premia (the extra return an investor expects to earn for taking on a higher risk). The result leaves investors expecting higher returns when risk of a crisis grows.

When threats rise, however, firms typically reduce spending on investments because raising capital becomes more expensive.

“We found that the connection between investors’ geopolitical risk perceptions, risk premia and firm investments is much looser when looking at existing acts than threats, in line with the idea that asset prices are forward-looking,” Melone said.

Gonçalves, Melone and Ricciardi found that GPT tracks investors’ perceptions of geopolitical risk and captures the extra return an investor expects to earn across assets and over time. It also captures time variation in country-level risk and firm investment.

“We looked at firm investment in such things as machinery, buying real estate and building factories,” Gonçalves said. “When we saw an increase in expectations of geopolitical threats, the index would see lower investments by firms in the subsequent quarters. It became more expensive for them to raise money and therefore they wanted to invest less.”

They also found that geopolitical threats predict cumulative consumption disasters ― major economic events like World War I, World War II and the Great Depression that lead to a significant and prolonged drop in household buying and spending ― over the long-term (five to ten years). Geopolitical acts, meanwhile, predict short-term shocks (one to three years).

According to Gonçalves, by the time a conflict takes place, asset prices already reflect the expected risk.

“We looked at surveys of fund managers and how strong geopolitical risk is over time,” said Gonçalves. “There’s a high correlation between the GPT index and the average geopolitical risk perception of fund managers; their responses make it feel like more geopolitical threats are present. But when war or another geopolitical act is happening, there’s not much higher risk perception. Prices aren’t going to go up and down by a lot more; the prices already have gone down substantially in anticipation so there’s not that much more money to lose.”

The researchers utilized existing, monthly news-based indices compiled from The New York Times, Chicago Tribune and The Washington Post that measured GPT and GPA dating back to 1927.

The indices tracked the number of unique words related to geopolitical threats or geopolitical acts, as well as what fraction of articles published every day contained the words. They covered war discourse, economic policy uncertainty and expected market volatility from 1927 to 2024. For a more modern view, the team also evaluated trade policy uncertainty and macroeconomic and financial uncertainty indices from the early 1960s until 2024.

“While the S&P sees big movements every day, geopolitical tensions are rare,” said Gonçalves. “In order to measure the effects of these events on financial assets, we needed a long sample to observe the effects on the financial market.”

“By distinguishing between threats and acts, our study shows that markets are driven not just by what happens, but by what investors fear might happen,” said Melone. “That forward-looking nature is what makes geopolitical risk so powerful — and so important to understand.”