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### Chapter 2 at a Glance
- Stock prices have generally had a modest reaction to geopolitical risk events, but major events—especially military conflicts—have a disproportionally larger and more persistent effect on asset prices.
- Sovereign risk premiums can increase notably in response to major geopolitical risk events, particularly in emerging market economies with weaker fiscal and external buffers.
- The impact of geopolitical risk events can spill over through trade and financial linkages, increasing the risk of financial contagion.
- Investors appear to price geopolitical risk into both equity and option markets to some extent; realization of these risks can raise financial market volatility.
- Geopolitical risks (conflicts, wars, terrorist attacks, military buildups, and restrictions on cross-border trade and financial transactions) have increased since 2022 compared with preceding years.
- A composite geoeconomic fragmentation index has reached its highest level in the last several decades.
- About 450 major geopolitical risk events were identified across countries over 1985–2024 (events defined as index scores at least two standard deviations above the country average).
- About one-sixth of the major events are international military conflicts; others involve diplomatic tensions, domestic political unrest, terrorism incidents, or trade restrictions.
- Aggregate stock prices exhibit a modest average reaction to major geopolitical risk events—about 3 percent—though some events produced substantially larger negative impacts, up to 9 percent on average across countries.
- Commodity-exporting countries often experience positive stock returns after major geopolitical risk events, while commodity-importing countries tend to suffer more.
- Extreme geopolitical events (for example, military interventions and wars) and longer-lasting conflicts tend to have more severe and persistent economic and financial impacts than shorter or less intense events.

### Asset‑price responses to geopolitical risk
- Equity markets
  - Aggregate stock prices generally decline by about 0.3 percent in response to a country-specific geopolitical risk shock; the effect is persistent and lasts at least two years after the shock.
  - Severe shocks (index increase ≥ two standard deviations) have effects about 7 times larger than a typical country-specific shock and are notably persistent.
  - Global geopolitical risk shocks have an average effect of about 1 percent on aggregate stock prices and persist for a quarter.
  - Baseline: the average three-month stock market return across countries in the chapter’s sample is about 0.1 percent. A typical geopolitical risk shock has an impact about three times as large, and a large geopolitical risk shock has an impact about 20 times larger, than the average stock market return.
  - Option-implied volatility (VIX) tends to spike after major domestic or global geopolitical shocks; increases in uncertainty are more notable and persistent, particularly for global shocks.
  - Market tail risks: geopolitical risk increases downside risks to aggregate stock prices (10th percentile); global geopolitical risk increases have a larger impact than country-specific risks and last about six months.
- Fixed‑income, currency, and commodity responses
  - Sovereign CDS spreads and long-term government bond yields react to geopolitical risk; sovereign risk premiums generally rise more in emerging markets and commodity non-exporters.
  - For commodity-importing countries, CDS spreads generally increase more than 1 percent cumulatively one week after major global geopolitical risk events; sovereign CDS spreads of commodity exporters typically decline.
  - Average sovereign CDS spreads and government bond yields increase slightly in advanced economies after major geopolitical risk events because of some large outlier observations, but median values generally decline.
  - Local currencies typically depreciate after major global geopolitical risk events, especially currencies of commodity-importing countries.
  - Commodity prices generally rise after major geopolitical risk events, particularly crude oil; energy-sector firms tend to benefit.
  - Precious metals are defined as the average prices of copper, palladium, platinum, and silver futures (on a continuous contract basis).
- Model and identification
  - Panel vector autoregression model identifying global and country-specific geopolitical risk shocks.
  - Benchmark variables: monthly industrial production, the consumer price index, real oil prices, real equity prices in US dollars, short- and long-term rates, and stock market option-implied volatility.
  - Geopolitical risk shocks ordered first (recursive identification), assuming structural shocks to geopolitical risk affect all variables contemporaneously.
  - Sample: largest 40 economies (advanced and emerging market and developing economies); commodity-exporters defined as commodities > 60 percent of total merchandise exports (UN Trade and Development data 2019–2021).

### Firm‑level exposure and cross‑border transmission
- Average firm response
  - Firm-level panel regression: stock returns decline, on average, by about 1 percentage point in the month of a major domestic geopolitical risk event; the average monthly firm-level stock return in the sample is about 0.6 percent.
  - International military conflicts produce larger effects: stock prices of firms in emerging market economies decline by about 5 percent, substantially larger than in advanced economies.
- Foreign spillovers via trade partners
  - Involvement of a country’s main trading partner in a major geopolitical event reduces stock returns for the country’s firms by about 1 percentage point on average; if the trading partner is involved in a military conflict, the impact can be up to 2.5 percentage points.
- Revenue, subsidiaries, and shareholders
  - Firms with significant revenues from, or subsidiaries/shareholding companies in, affected countries experience additional declines of 0.1–0.25 percentage points, controlling for other macro and sectoral effects.
  - In emerging markets the impact operates primarily through shareholding companies rather than subsidiaries; about one-third of the impact on emerging market stock prices appears to be driven by exchange rate movements vis-à-vis the US dollar.
- Sample for firm analysis: more than 60,000 firms located in 20 advanced and 20 emerging market economies.

### Selected event case studies
- Russia’s 2022 invasion of Ukraine
  - Russia’s stock market plummeted by 33 percent on February 24, 2022.
  - Ukrainian stock exchange trading was suspended; market impact muted due to low liquidity and few listed firms.
  - Firms with high revenue exposures to Russia or Ukraine (two standard deviations above sample average) cumulatively declined about 0.7 percentage points seven days after the invasion, controlling for country- and sector-specific factors.
  - Stock returns of firms with a subsidiary in Russia or Ukraine declined 2.5 percentage points, on average, a week after the war began.
  - Average revenue exposure of firms to Russia or Ukraine before the war was about 0.1 percent; a two-standard-deviation increase represents about 1.3 percent revenue exposure.
  - Share of firms with subsidiaries in Russia declined from > 2 percent in 2015–21 to about 1.5 percent in 2023; size of subsidiaries in Russia halved from about 0.3 percent of firms’ total assets to about 0.14 percent.
  - Funds reduced exposures to Russia and Ukraine by 60 percent after the invasion.
- China–US trade tensions (tariff announcements, 2018–24)
  - After US announcements of tariffs on China, stock prices of Chinese firms declined by nearly 4 percent, on average.
  - Average stock return in these firms in the two-year period prior to tariffs was about 0.1 percent.
  - Stock returns declined by almost 8 percent on May 6, 2019, when the US announced tariff increases on Chinese products amounting to $200 billion.
  - US firms’ stock prices declined by 1.3 percent, on average, after US tariff announcements.
  - China’s retaliatory tariff announcement on August 23, 2019, saw US firms’ stock prices fall by 1.6–1.8 percent, on average; Chinese firms’ stock prices declined by 0.3–0.7 percent.
  - Tariff effects spilled across sectors; firms with revenue exposure or subsidiaries across the US–China divide experienced additional declines (examples: Chinese firms with US revenue exposure ≈ 0.2 percentage points more; US and Chinese firms with subsidiaries in the other country ≈ 0.6 percentage points more).
  - Event selection focuses on significant tariff increases or new tariffs; key US tariff announcement dates used include March 22, 2018; May 6, 2019; August 1, 2019; and May 14, 2024. China’s retaliatory increase referenced is August 23, 2019.

### Sovereign risk premiums, yields, and fiscal feedbacks
- Sovereign CDS spreads and yields
  - Within one month of a country’s involvement in a major international military conflict, sovereign CDS spreads widen by about 40 basis points in advanced economies and by about 180 basis points in emerging market economies.
  - Sovereign risk premiums increase when trading partners are involved in international military conflicts; effects measured with trade-weighted exposure (a 10 percent greater weight in total trade corresponds to about 2.5 standard deviations of trade shares in the sample).
- Amplifying factors for foreign geopolitical events
  - Sovereign risk premiums increase more in emerging market economies with public-debt-to-GDP ratios above the median in the emerging markets sample.
  - Sovereign CDS premiums increase by 100 basis points more in economies with international reserve adequacy ratios below the sample median.
  - Sovereign CDS premiums increase by 120 basis points in economies with institutional quality below the sample median (institutional quality = average of ICRG scores on bureaucracy quality, corruption, democratic accountability, investment profile, and law and order).
- Safe haven and yield responses
  - Long-term sovereign bond yields tend to decline in safe haven countries (Germany, Japan, Switzerland, the United Kingdom, and the United States) following major geopolitical risk events.
  - Following major domestic geopolitical events: long-term yields decline in advanced economies (driven mainly by safe haven countries) and increase in emerging markets.
  - Safe haven effects are more pronounced for major foreign geopolitical events: long-term yields notably increase in other advanced economies but not in traditional safe haven countries.
- Fiscal feedback loop
  - Geopolitical events can increase sovereign risk via higher military spending and weaker economic activity, raising public-debt-to-GDP ratios and amplifying fiscal vulnerabilities that feedback on sovereign risk premiums and the banking sector.

### Pricing of geopolitical risk in equity and options markets
- Equity pricing methodology and findings
  - Two-step asset-pricing: (1) estimate GPR betas via time-series regressions of firm-level returns on risk factors; (2) estimate time series of risk premiums via Fama and MacBeth (1973) cross-sectional regressions, controlling for market, size, book-to-market, and momentum.
  - Decile portfolio: buying highest-decile GPR beta stocks and selling lowest-decile; controls include Fama-French (1993) three factors and momentum.
  - GPR beta distribution nearly symmetric with many stocks exhibiting positive and negative betas (sample period up to September 2024).
  - Sector patterns: energy and defense sectors exhibit higher GPR betas; consumer goods sector tends to have lower GPR betas.
  - Historical premiums:
    - 2012–21: a one-percentage-point difference in GPR betas leads to a negative premium of 0.01 percentage points (one-month-ahead excess return proxy).
    - After 2022: that premium turned positive.
    - Decile portfolio performance:
      - Generated statistically significant negative premiums of about 0.5 percent per month during 2012–21.
      - Generated a positive premium of about 1.1 percent per month after 2022.
    - Interpretation: before Russia’s 2022 invasion of Ukraine, investors demanded a premium for holding stocks that responded negatively to geopolitical risks; after 2022, investors favored stocks that served as a hedge.
- Options market pricing
  - Out-of-the-money put options used to measure costs of protection against downside and tail risks; implied volatility curves by moneyness estimate premiums.
  - Russia’s 2022 invasion of Ukraine:
    - Premiums for downside and tail-risk protection increased moderately before the invasion and surged around the event.
    - Premium increases largest for options on Russian firms and rose for firms in European countries.
    - Premiums remained stable in the energy sector; higher for firms with greater exposure to Russia and Ukraine.
  - China–US tariff announcements (2018–19):
    - Option premiums for downside and tail-risk protection increased for Chinese and US firms after tariff announcements.
    - Premium increases stronger for tail-risk protection than for downside-risk protection.

### Banks, investment funds, exposures, and vulnerabilities
- Cross-border banking claims and liabilities
  - Cross-border claims involving countries afflicted by major geopolitical events were about 8 percent of total cross-border bank claims as of the second half of 2024.
  - Cross-border liabilities involving such countries were about 10 percent of total cross-border bank liabilities as of the second half of 2024.
  - Average share of cross-border bank claims on countries involved in major geopolitical events was about 3 percent on average from Q1 2000 to Q1 2024.
  - Cross-border bank claims on Russia and Ukraine fell significantly after the annexation of Crimea in 2014 and after Russia’s invasion of Ukraine in Q1 2022.
- Equity funds’ holdings
  - The share of holdings by equity funds of assets domiciled in countries experiencing major geopolitical events reached 13 percent of these funds’ assets in 2024.
  - Smaller funds tend to have greater exposure than larger funds (weighted average of shares across funds yields values 3–4 percentage points lower).
  - Funds reduced exposures to Russia and Ukraine by 60 percent after Russia’s invasion of Ukraine.
- Effects on bank capital, lending, and vulnerabilities
  - Major geopolitical events generally adversely affect bank capital and lending, with stronger impacts in emerging markets.
  - Reported averages:
    - Average annual change in equity-to-total-assets (lagged) ratio = 0.4 for emerging markets and 0.4 for advanced economies.
    - Loan growth averages = 8 percent for emerging markets and 4.4 percent for advanced economies.
  - Bank equity tends to decline when a bank’s home country or key foreign counterparts are involved in an international military conflict, contributing to loan growth declines.
  - Results based on unbalanced panel of > 6,000 banks from 21 advanced economies and 15 emerging markets.
- Impact on investment funds: returns and flows
  - International military conflicts and major geopolitical events reduce fund performance and attract outflows; bond funds generally more affected than equity funds.
  - Reported elasticities/effects:
    - Across international military conflicts, bond funds with 10 percent exposure to affected countries suffered a 1.0 percentage point decrease in returns and a 2.3 percentage point decline in flows.
    - Equity funds: about a 0.2 percentage point decrease in returns and a 0.3 percentage point decline in flows.
    - After Russia’s invasion of Ukraine, funds with 10 percent holdings directly exposed to Russian or Ukrainian assets experienced about a 6 percent decline in cumulative returns within a week and an 8 percent decrease in cumulative flows over the subsequent six months.
    - Funds with 10 percent of assets from issuers generating substantial revenue from, or having subsidiaries in, Russia or Ukraine saw declines of about 0.2 percent (returns) and 0.3 percent (flows), respectively.
    - China–US tariff announcements: funds with an additional 10 percent exposure to Chinese firms directly affected by US tariffs decreased cumulative returns by about 0.1 percent in the month after the US tariff announcements; no statistically significant impact on flows was observed.
- Operational and structural risks
  - Geopolitically driven market fragmentation, sanctions, capital controls, and cyberattack risks can impede operational resilience and market functioning.
  - Rapid outflows can exacerbate fragility in less liquid asset markets; redemption pressures can trigger margin and collateral calls and potential asset fire sales.

### Geopolitical risk and tail risks to stock markets (Box 2.1)
- Framework
  - A two-standard-deviation increase in the (log) global geopolitical risk index is used to quantify downside risk to cumulative stock returns at horizons of 1, 3, 6, and 12 months.
  - Results disaggregated for advanced economies (AEs) and emerging markets (EMs); outcomes expressed in percentage points with 95 percent confidence intervals.
- Main empirical finding
  - A two-standard-deviation increase in the global geopolitical risk index is, on average, associated with a decline of 2 percentage points in downside tail risks to stock market returns (10th percentile) in advanced economies at a six-month horizon.
  - For emerging market economies, a two-standard-deviation increase raises downside tail risks but the effect is not statistically significant on average; large country-specific geopolitical events (index scores two standard deviations above the country-specific average) raise downside tail risk to stock returns by about 3 percentage points.
- Analysis specifics
  - Focus on the 10th percentile of cumulative stock returns over 1-, 3-, 6-, and 12-month horizons with controls standardized at the country level: three-month domestic CPI inflation, three-month percentage change in real industrial production, average stock market dividend yield, detrended short-term interest rate, domestic term spread, three-month daily stock market volatility, price-to-earnings ratio.
  - Sample covers about 30 advanced and emerging market economies for 1990–2024.

### Conclusions and policy recommendations
- Key conclusions
  - Major geopolitical risk events can threaten macrofinancial stability by affecting asset prices, bank and nonbank financial institutions’ performance and intermediation capacity, and by triggering cross-border contagion through trade and financial linkages.
  - Countries with limited fiscal and international reserve buffers are particularly vulnerable to rises in sovereign risk premiums.
  - If geopolitical shocks become larger, more frequent, or more persistent than those analyzed, they could have more severe impacts on asset prices and macrofinancial stability.
- Policy recommendations for financial institutions and policymakers
  - Financial institutions should devote adequate resources to identifying, quantifying, and managing geopolitical risks.
  - Policymakers should explore implications of geopolitical risks for supervision and regulation of financial institutions; scenario analysis and stress testing should incorporate interactions of geopolitical risks with market, credit, and liquidity risks.
  - Collect data on financial institutions’ direct and indirect exposures to geopolitical risk to support scenario analysis and stress testing.
  - Ensure capital and liquidity buffers can absorb extreme but plausible losses associated with materialized geopolitical risks.
  - Strengthen policy tools to address financial stability consequences of stress in nonbank financial intermediaries, including liquidity management tools by open-end funds to mitigate systemic impact from abrupt outflows.
  - Strengthen crisis preparedness and management frameworks for potential financial instability from escalation of geopolitical tensions.
  - Continue to deepen and develop financial markets in emerging market and developing economies with robust regulatory frameworks (including clear guidelines for the use of derivatives and other instruments).
  - Maintain adequate fiscal policy space and international reserves; contain fiscal vulnerabilities to limit amplifying effects of high public debt on sovereign borrowing costs and manage risks from potential capital flow volatility in line with the IMF’s Integrated Policy Framework.

*Source: CHAPTER 2 GEOPOLITICAL RISkS: IMPLICATIONS FOR ASSET PRICES ANd FINANCIAL STABILITY, Global Financial Stability Report, International Monetary Fund | April 2025*

### Chapter 2 at a Glance

### Chapter 2 at a Glance

### Key Findings
- Stock prices have generally had a modest reaction to geopolitical risk events, but major events—especially military conflicts—have a disproportionally larger and more persistent effect on asset prices.
- Sovereign risk premiums can increase notably in response to major geopolitical risk events, particularly in emerging market economies with weaker fiscal and external buffers.
- The impact of geopolitical risk events can spill over to sovereigns and firms in other countries through trade and financial linkages, increasing the risk of financial contagion.
- Investors appear to price geopolitical risk into both equity and option markets to some extent; however, the realization of these risks can raise financial market volatility.
- Geopolitical risk events can adversely affect the stability and intermediation capacity of banks and non-bank financial institutions, such as investment funds, with potential impacts on macrofinancial stability.
- Geopolitical risks, including conflicts, wars, terrorist attacks, military buildups, and restrictions on cross-border trade and financial transactions, have increased since 2022 compared with levels in preceding years.
- A composite measure combining indicators of geopolitical risk and fragmentation—the geoeconomic fragmentation index—has reached its highest level in the last several decades.
- The chapter identifies about 450 major geopolitical risk events across countries over 1985–2024; events are defined as “major” if their scores on the index are at least two standard deviations above the average score for the country where they occurred.
- About one-sixth of the events classified as major are international military conflicts; others involve diplomatic tensions, domestic political unrest, terrorism incidents, or the announcement and implementation of trade restrictions.
- Aggregate stock prices exhibit a modest average reaction to major geopolitical risk events—about 3 percent—though some events have caused a substantially larger negative impact, up to 9 percent on average across countries.
- Commodity-exporting countries often experience positive stock returns after major geopolitical risk events, while commodity-importing countries tend to suffer more.
- Extreme geopolitical events (for example, military interventions and wars) and longer-lasting conflicts tend to have more severe and persistent economic and financial impacts than shorter or less intense events.

### Policy Recommendations
- Policymakers should consider country-specific geopolitical risks in their oversight of financial institutions. Financial institutions should devote adequate resources to identifying, quantifying, and managing such risks (April 2023 Global Financial Stability Report).
- Financial institutions should hold adequate capital and liquidity buffers to protect against extreme but plausible losses associated with the materialization of geopolitical risks.
- Emerging market and developing economies should continue efforts to deepen financial markets, accompanied by robust regulatory frameworks, to help investors manage and hedge against financial risks posed by geopolitical shocks.
- Adequate macroeconomic policy space and international reserve buffers should be maintained to help mitigate the adverse effects of geopolitical risk events.

### Transmission Channels and Stylized Facts
- Two key channels transmit geopolitical risk to asset prices:
  - Economic channel: restrictions on trade and financial transactions, supply-chain disruptions, capital flow reversals, cross-border payments disruption, and physical/civilian damage can directly affect growth, inflation, and asset cash flows (for example, supply disruptions may raise commodity prices but lower equity valuations).
  - Market sentiment channel: increased geopolitical risk raises macroeconomic and financial uncertainty, reducing investor confidence and increasing risk aversion, which can depress valuations and raise volatility.
- Elevated geopolitical risk can lead to higher sovereign yield spreads or credit default swap (CDS) spreads if fiscal sustainability concerns rise (for example, due to increased spending and borrowing needs or output declines).
- Depressed asset valuations increase liquidity and credit risks for financial and nonfinancial institutions; large and abrupt declines can trigger margin and collateral calls and redemption pressures on investment funds, potentially causing asset fire sales and contagion.
- Historical evidence since World War II: major geopolitical events typically trigger a modest and short-lived decline in aggregate stock prices, but notable exceptions (for example, the 1973 Arab oil embargo and the 1990 Iraq invasion of Kuwait) produced stronger and more persistent adverse stock market reactions lasting over several months.
- News-based geopolitical risk indices (Caldara and Iacoviello 2022) are used to capture both realization and perception of geopolitical risk; country-specific indices capture articles that mention a country or its major cities and tend to be highly correlated with other text-based indices for large, advanced countries.

*Source: Chapter 2 (at a glance) — CHAPTER 2 GEOPOLITICAL RISKS: IMPLICATIONS FOR ASSET PRICES AND FINANCIAL STABILITY, Global Financial Stability Report, International Monetary Fund | April 2025*

### 1. Average Weekly Cumulative Change in Stock Market Returns

### 1. Average Weekly Cumulative Change in Stock Market Returns

### Asset-price responses to major geopolitical risk events
- Equity markets: aggregate stock prices generally decline by about 0.3 percent in response to a country-specific geopolitical risk shock; the effect is persistent and lasts at least two years after the shock.
- Severe shocks: shocks that increase the geopolitical risk index by at least two standard deviations have an effect about 7 times larger than the typical country-specific shock and are notably persistent.
- Global shocks: global geopolitical risk shocks have an average effect of about 1 percent on aggregate stock prices and persist for a quarter.
- Baseline comparison: the average three-month stock market return across countries in the chapter’s sample is about 0.1 percent. A typical geopolitical risk shock has an impact about three times as large, and a large geopolitical risk shock has an impact about 20 times larger, than the average stock market return.
- Option-implied volatility (VIX): the VIX tends to spike after major domestic or global geopolitical shocks; both risk aversion and uncertainty increase, but the effect on uncertainty is more notable and persistent, particularly for global shocks.
- Market tail risks: increases in geopolitical risk raise downside risks to aggregate stock prices (prices at the 10th percentile); global geopolitical risk increases have a quantitatively larger impact than country-specific risks and last about six months.

### Fixed‑income, currency, and commodity responses
- Sovereign risk premiums and yields: sovereign CDS spreads and long-term government bond yields react to geopolitical risk; sovereign risk premiums generally rise more in emerging markets and commodity non-exporters.
- Sovereign CDS spreads: for commodity-importing countries, CDS spreads generally increase more than 1 percent cumulatively one week after major global geopolitical risk events; by contrast, sovereign CDS spreads of commodity exporters typically decline.
- Government bond yields: average sovereign CDS spreads and government bond yields increase slightly in advanced economies after major geopolitical risk events because of some large outlier observations, but median values generally decline.
- Currencies: local currencies typically depreciate after major global geopolitical risk events, especially currencies of commodity-importing countries.
- Commodity prices: commodity prices generally rise after major geopolitical risk events, particularly crude oil; energy-sector firms tend to benefit.
- Commodity futures: precious metals are defined as the average prices of copper, palladium, platinum, and silver futures (on a continuous contract basis).

### Model, identification, and sample
- Empirical approach: a panel vector autoregression model is used to identify effects of geopolitical risk shocks on aggregate stock prices, differentiating global and country-specific geopolitical risk shocks.
- Benchmark model variables: monthly industrial production, the consumer price index, real oil prices, real equity prices in US dollars, short- and long-term rates, and stock market option-implied volatility.
- Identification: geopolitical risk shocks are plausibly identified recursively (ordered first), assuming structural shocks to geopolitical risk affect all variables contemporaneously.
- Sample composition: the sample includes the largest 40 economies, classified as advanced and emerging market and developing economies; commodity-exporting countries are defined as those for which commodities constitute more than 60 percent of total merchandise exports (UN Trade and Development data from 2019 to 2021).

### Firm‑level exposure and cross‑border transmission
- Average firm response: firm-level panel regression finds stock returns decline, on average, by about 1 percentage point in the month of a major domestic geopolitical risk event; the average monthly firm-level stock return in the sample is about 0.6 percent.
- Severity and country group differences: international military conflicts produce larger effects, with stock prices of firms in emerging market economies declining by about 5 percent, a substantially larger effect than in advanced economies.
- Foreign spillovers via trade partners: involvement of a country’s main trading partner in a major geopolitical risk event reduces stock returns for the country’s firms by about 1 percentage point on average; when a country’s main trading partner is involved in a military conflict, the impact can be up to 2.5 percentage points.
- Revenue, subsidiaries, and shareholders: firms that generate a significant proportion of revenues from, or have subsidiaries or shareholding companies in, countries affected by a geopolitical risk event experience an additional decline in their stock prices of 0.1–0.25 percentage points, controlling for other macro and sectoral effects.
- Channel heterogeneity in emerging markets: for emerging market firms, the impact appears to operate primarily through shareholding companies rather than subsidiaries; about one-third of the impact on emerging market stock prices appears to be driven by exchange rate movements vis-à-vis the US dollar.
- Sample for firm analysis: the firm-level estimates are based on a sample of more than 60,000 firms located in 20 advanced and 20 emerging market economies.

*Sources: Bloomberg Finance L.P.; LSEG Datastream; UN Trade and Development; IMF, Global Data Source; Caldara and Iacoviello (2022); Bekaert, Hoerova, and Lo Duca (2013); Bekaert, Engstrom, and Xu 2022; Chicago Board Options Exchange; IMF staff calculations.*

### CHAPTER 2 GEOPOLITICAL RISkS: IMPLICATIONS FOR ASSET PRICES ANd FINANCIAL STABILITY

### CHAPTER 2 GEOPOLITICAL RISkS: IMPLICATIONS FOR ASSET PRICES ANd FINANCIAL STABILITY

### Stock market impacts of Russia’s 2022 invasion of Ukraine
- Russia’s stock market plummeted by 33 percent on February 24, 2022.
- Ukrainian stock exchange trading was suspended; the Ukrainian market impact was muted, reflecting low liquidity and a limited number of listed firms before the invasion.
- Firms with high revenue exposures to Russia or Ukraine—defined as two standard deviations above the average exposure in the sample—had cumulatively declined about 0.7 percentage points seven days after the invasion, after accounting for country- and sector-specific factors.
- Stock returns of firms with a subsidiary in Russia or Ukraine declined 2.5 percentage points, on average, a week after the war began.
- Firm-level analyses measure cumulative stock returns in US dollars for 7 and 21 days after February 24, 2022, and control for country-specific fixed effects.

### Firms’ exposure to Russia and reorientation of linkages
- The average revenue exposure of firms in the sample to Russia or Ukraine before the onset of the war was about 0.1 percent; a two-standard-deviation increase represents firm revenue exposure of about 1.3 percent.
- The share of firms with subsidiaries in Russia declined from more than 2 percent in 2015–21 to about 1.5 percent in 2023.
- The size of subsidiaries in Russia halved, from about 0.3 percent of firms’ total assets to about 0.14 percent.
- The share of firms with revenue exposure to Russia remained somewhat stable on average, but the median and country-level patterns show notable variation—revenue exposure declined for firms in several European countries and increased in some other countries (from relatively low levels).
- These patterns suggest possible reorientation of trade and investment linkages after major geopolitical risk events, with potential near-term disruption for some countries.

### China–US trade tensions: tariff announcements and firm stock returns
- Stock prices reacted negatively to tariff announcements by China and the US during 2018–24.
- After announcements of tariffs on China by the US, the stock prices of Chinese firms declined by nearly 4 percent, on average.
- The average stock return in these firms in the two-year period prior to the imposition of these tariffs was about 0.1 percent.
- Stock returns declined by almost 8 percent on May 6, 2019, when the US announced tariff increases on Chinese products amounting to $200 billion.
- US firms’ stock prices declined by 1.3 percent, on average, after the US government made announcements regarding tariffs on China.
- China’s retaliatory tariff announcement on August 23, 2019, saw US firms’ stock prices fall by 1.6–1.8 percent, on average; Chinese firms’ stock prices declined by 0.3–0.7 percent.
- Tariff effects were not limited to directly targeted sectors: firms in sectors facing tariffs and firms in other sectors both experienced declines, indicating interconnectedness and broader uncertainty.
- Tariff effects by firm linkage:
  - Chinese firms that had revenue exposure to the United States before a US tariff announcement experienced stock returns that declined by about 0.2 percentage points more than comparable firms without such revenue exposure.
  - After a US tariff announcement, the stock returns of both US firms with subsidiaries in China and Chinese firms with a subsidiary in the US dropped, on average, by 0.6 percentage points more than returns of comparable firms without such subsidiary presence.
- Event selection: analyses focus on significant tariff increases or new tariffs and exclude modifications or announcements not implemented. Key US tariff announcement dates used include March 22, 2018; May 6, 2019; August 1, 2019; and May 14, 2024. China’s retaliatory increase referenced is August 23, 2019.

### Response of sovereign risk premiums to geopolitical risk
- Sovereign CDS spreads widen significantly after major geopolitical risk events, most notably during military conflicts.
- Within one month of a country’s involvement in a major international military conflict, sovereign CDS spreads widen by about 40 basis points in advanced economies and by about 180 basis points in emerging market economies.
- Sovereign risk premiums also increase when trading partners are involved in international military conflicts; effects are measured with trade-weighted exposure (a 10 percent greater weight in total trade corresponds to about 2.5 standard deviations of trade shares in the sample).
- Amplifying factors for foreign geopolitical events:
  - Sovereign risk premiums increase more in emerging market economies with high public-debt-to-GDP ratios (defined as those above the median in the emerging markets sample) when their key trading partners are involved in an international military conflict.
  - Sovereign CDS premiums increase by 100 basis points more in economies with international reserve adequacy ratios below the sample median.
  - Sovereign CDS premiums increase by 120 basis points in economies with institutional quality below the sample median. “Institutional quality” is the average of ICRG’s scores on bureaucracy quality, corruption, democratic accountability, investment profile, and law and order.
- Long-term sovereign bond yields tend to decline in safe haven countries following major geopolitical risk events. Safe haven countries considered include Germany, Japan, Switzerland, the United Kingdom, and the United States.
- Mechanisms: increases in geopolitical risk can raise sovereign risk via higher military spending affecting fiscal outlook, and via deterioration in economic activity increasing public-debt-to-GDP ratios—thus affecting financial stability through sovereign–financial sector interconnectedness.

*Source: CHAPTER 2 GEOPOLITICAL RISkS: IMPLICATIONS FOR ASSET PRICES ANd FINANCIAL STABILITY, International Monetary Fund | April 2025*

### Annex 2.7 for details. AE = advanced economies; AE* = advanced economies excluding traditional safe haven countries; EM 

### ch2 - Annex 2.7 for details. AE = advanced economies; AE* = advanced economies excluding traditional safe haven countries; EM

### Effects on sovereign yields and fiscal feedbacks
- Long-term sovereign yields in countries traditionally considered safe havens tend to decline following geopolitical risk events.
- Following major domestic geopolitical risk events:
  - Long-term sovereign yields tend to decline in advanced economies, driven mainly by safe haven countries.
  - Yields in emerging markets tend to increase.
- Safe haven effects are more pronounced for major foreign geopolitical risk events: long-term yields tend to notably increase in other advanced economies but not so in traditional safe haven countries.
- Geopolitical events can create a feedback loop with fiscal risk:
  - A significant geopolitical event can increase sovereign risk premiums, amplifying fiscal vulnerabilities.
  - Increased fiscal vulnerabilities can further exacerbate the impact of the geopolitical shock on sovereign risk premiums, which may adversely affect banks’ balance sheets and lending, especially in countries with less well-capitalized banking systems and higher fiscal vulnerabilities.
- Cross-references: April 2025 Fiscal Monitor; April 2022 Global Financial Stability Report, Chapter 2.

### Pricing of geopolitical risk in equity markets
- Methodology summary:
  - Two-step asset-pricing approach: (1) estimate exposures (GPR betas) using time-series regressions of firm-level stock returns on risk factors; (2) estimate time series of risk premiums via Fama and MacBeth (1973) cross-sectional regressions, controlling for market, size, book-to-market ratio, and momentum.
  - Decile portfolio analysis buys stocks with GPR betas in the highest decile and sells those in the lowest decile; regression controls include Fama-French (1993) three factors and momentum; alphas indicate risk-adjusted premiums.
- Heterogeneous stock responses:
  - The geopolitical risk (GPR) beta distribution is nearly symmetric with many stocks exhibiting both positive and negative GPR betas (sample period up to September 2024).
  - Sector patterns:
    - Energy and defense sectors exhibit higher GPR betas (value tends to rise after a geopolitical risk shock).
    - Consumer goods sector tends to have lower GPR betas.
- Historical premiums and shifts:
  - Between 2012 and 2021, a one-percentage-point difference in GPR betas (equivalent to the difference between the average GPR beta for the energy sector and that for all other firms) leads to a negative premium of 0.01 percent-age points (proxied by cross-sectional variation in one-month-ahead excess return across stocks).
  - That premium turned positive after Russia’s invasion of Ukraine in 2022.
  - A portfolio that buys stocks with GPR betas in the highest decile and sells those in the lowest decile:
    - Generated statistically significant negative premiums of about 0.5 percent per month during 2012–21.
    - Generated a positive premium of about 1.1 percent per month after 2022.
  - Interpretation: before Russia’s 2022 invasion of Ukraine, investors demanded a premium for holding stocks that responded negatively to geopolitical risks; after 2022, they favored stocks that served as a hedge.

### Pricing of geopolitical risk in options markets
- Rationale: out-of-the-money put options measure costs of protection against downside and tail risks; implied volatility curves related to option “moneyness” (delta) are used to estimate premiums.
- Russia’s 2022 invasion of Ukraine:
  - Premiums for protection against downside risk and additional premiums for downside tail risks increased moderately before the invasion and surged notably around the event.
  - Premium increases were largest for options on Russian firms, and also rose for firms in European countries.
  - Sectoral breakdowns:
    - Premiums remained stable in the energy sector.
    - Options on firms with higher exposure to Russia and Ukraine (via subsidiaries or revenues) faced higher premiums.
  - Panel measures indexed to event windows: indices use 22 weeks before invasion = 100 (panels 1–3) and 2 weeks before invasion = 100 (panel 4).
- China–US trade tensions (tariff announcements in 2018–19):
  - Option premiums for protecting against downside and tail risks increased for Chinese and US firms after the tariff announcements.
  - Premiums did not increase, on average, for options on firms in other countries after these announcements.
  - The increase in option premiums was stronger for tail-risk protection than for downside-risk protection, indicating a stronger perceived impact on tail risks from China–US trade tensions.

### Implications for the financial system
- Geopolitically driven market volatility, macroeconomic uncertainty, and activity disruptions can elevate market, liquidity, and credit risks for banks and nonbank financial institutions.
- Rapid asset price changes and selloffs can:
  - Cause significant fluctuations in the value of financial assets held by institutions.
  - Impact institutions’ balance sheets, risk-taking capacity, and funding conditions.
  - Trigger adverse macrofinancial feedback loops.
- Investment fund vulnerabilities:
  - Rapid outflows after geopolitical shocks can exacerbate fragility in less liquid asset markets.
- Operational and structural risks:
  - Increased risk of cyberattacks and market fragmentation due to sanctions and capital controls can challenge operational resilience.
- Cross-references: April 2023 Global Financial Stability Report; October 2022 Global Financial Stability Report, Chapter 3; April 2022 and April 2024 Global Financial Stability Reports.

### Exposure of banks and investment funds to geopolitical shocks
- Cross-border banking claims and liabilities involving countries afflicted by major geopolitical risk events (events defined as values more than two standard deviations above the average on geopolitical risk indices) were:
  - About 8 percent of total cross-border bank claims as of the second half of 2024.
  - About 10 percent of total cross-border bank liabilities as of the second half of 2024.
- Equity funds’ holdings:
  - The share of holdings by equity funds of assets domiciled in countries experiencing major geopolitical risk events reached 13 percent of these funds’ assets in 2024.
- Historical adjustment to exposures:
  - Cross-border bank claims on Russia and Ukraine fell significantly after the annexation of Crimea in 2014 and after Russia’s invasion of Ukraine in the first quarter of 2022.
  - Banks’ exposure to countries involved in major geopolitical risk events has increased considerably over time: the average share of cross-border bank claims on such countries was about 3 percent on average from Q1 2000 to Q1 2024.
- Asset-class and sectoral notes:
  - Most banking sectors and investment funds hold assets in countries exposed to major geopolitical risk events, underscoring industry concerns about geopolitical risks.

*International Monetary Fund | April 2025 — Chapter 2, Annex 2.7 and related figures and analysis*

### 1. Banks’ Exposure to Countries Experiencing Major Geopolitical

### Banks’ Exposure to Countries Experiencing Major Geopolitical Risk Events

### Banks’ and Investment Funds’ Exposures and Rebalancing
- Investment funds and banking sectors have meaningful direct and indirect exposures to countries experiencing major geopolitical risk events; smaller funds tend to have greater exposure than larger funds (weighted average of shares across funds yields values that are three to four percentage points lower).
- Investment funds reduced exposures to Russia and Ukraine:
  - Funds reduced exposures to both countries by 60 percent after Russia’s invasion of Ukraine.
  - Funds reduced holdings of firms in third countries with high (above the country-sectoral median) revenue or subsidiary exposures to Russia or Ukraine.
- Panel measures and methodology (as reported):
  - Panel 1: 4-quarter moving averages for cross-border exposures of banking sectors, through claims or liabilities on a consolidated immediate basis measured at the end of the quarter.
  - Panel 2: weighted 4-quarter moving averages for fund holding positions at end of quarters, averaged across individual funds (within fund types).
  - Panel 3: change in total cross-border banking claims on Russia and Ukraine relative to total cross-border banking claims, expressed as the cumulative percent change relative to the first quarter of 2010.
  - Panel 4: change in portfolio exposures compared with one quarter before the event (that is, in the fourth quarter of 2021); exposures weighted and held at constant pre-event prices.

### Effects on Bank Capital, Lending, and Vulnerabilities
- Major geopolitical risk events generally have an adverse effect on bank capital and lending, with stronger impacts in emerging market economies due to greater vulnerability and weaker capacity to absorb shocks.
- Empirical magnitudes and context (reported averages and comparisons):
  - The average annual change in the equity-to-total-assets (lagged) ratio and loan growth are 0.4 and 8 percent, respectively, for emerging markets and 0.4 and 4.4 percent, respectively, for advanced economies.
- Specific findings:
  - Bank equity tends to decline when a bank’s home country or key foreign counterparts are involved in an international military conflict (contributing to a decline in loan growth).
  - Foreign geopolitical risk events can cause cross-border claims to lose value and make rolling over foreign wholesale debt more difficult, especially when events affect key counterparts.
  - Results are based on an unbalanced panel of more than 6,000 banks from 21 advanced economies and 15 emerging markets, with controls for a large set of bank and macro variables and bank and year fixed effects; reported magnitudes in panels for foreign events correspond to a one-standard-deviation increase in the weighted average of indicator variables for major foreign geopolitical risk events.

### Impact on Investment Funds: Returns and Flows
- International military conflicts and other major geopolitical events reduce fund performance and attract outflows, with bond funds generally more affected than equity funds.
- Reported elasticities and effects:
  - Across international military conflicts, bond funds with a 10 percent exposure of fund holdings to countries affected by a conflict subsequently suffered a 1.0 percentage point decrease in returns and a 2.3 percentage point decline in flows.
  - The impact was, on average, smaller for equity funds: about a 0.2 percentage point decrease in returns and a 0.3 percentage point decline in flows.
  - After Russia’s invasion of Ukraine, investment funds with 10 percent of their holdings directly exposed to Russian or Ukrainian assets experienced about a 6 percent decline in cumulative returns within a week and an 8 percent decrease in cumulative flows over the subsequent six months.
  - Funds with 10 percent of their assets from issuers generating substantial revenue from, or having subsidiaries in, Russia or Ukraine saw declines of about 0.2 percent (returns) and 0.3 percent (flows), respectively.
  - China–US tariff announcements: funds with an additional 10 percent exposure to Chinese firms directly affected by US tariffs decreased cumulative returns by about 0.1 percent in the month after the US tariff announcements; no statistically significant impact on flows was observed.

### Geopolitical Risk and Tail Risks to Stock Markets
- Global geopolitical risk increases the likelihood of large future stock market corrections:
  - A two-standard-deviation increase in the global geopolitical risk index is, on average, associated with a decline of 2 percentage points in downside tail risks to stock market returns (defined as the 10th percentile of the distribution of aggregate stock market returns) in advanced economies at a six-month horizon.
  - For emerging market economies, a two-standard-deviation increase raises downside tail risks but the effect is not statistically significant on average; large country-specific geopolitical risk events (index scores two standard deviations above the country-specific average) raise downside tail risk to stock returns by about 3 percentage points.
- The analysis focuses on the 10th percentile of cumulative stock returns over 1-, 3-, 6-, and 12-month horizons and includes controls standardized at the country level (three-month domestic CPI inflation, three-month percentage change in real industrial production, average stock market dividend yield, detrended short-term interest rate, domestic term spread, three-month daily stock market volatility, price-to-earnings ratio). Sample covers about 30 advanced and emerging market economies for 1990–2024.
- Geopolitical acts (rather than threats) have a stronger impact on downside tail risks to stock markets.

### Conclusion and Policy Recommendations
- Key conclusions:
  - Major geopolitical risk events can threaten macrofinancial stability by affecting asset prices, bank and nonbank financial institutions’ performance and intermediation capacity, and by triggering cross-border contagion through trade and financial linkages.
  - Countries with limited fiscal and international reserve buffers are particularly vulnerable to rises in sovereign risk premiums.
  - If geopolitical shocks become larger, more frequent, or more persistent than those analyzed, they could have more severe impacts on asset prices and macrofinancial stability.
- Recommendations for financial institutions and policymakers:
  - Financial institutions should devote adequate resources to identifying, quantifying, and managing geopolitical risks.
  - Policymakers should explore implications of geopolitical risks for supervision and regulation of financial institutions; scenario analysis and stress testing should incorporate interactions of geopolitical risks with market, credit, and liquidity risks to assess transmissions to financial institutions.
  - Collect data on financial institutions’ direct and indirect exposures to geopolitical risk to support scenario analysis and stress testing.
  - Ensure capital and liquidity buffers at financial institutions can absorb extreme but plausible losses associated with materialized geopolitical risks.
  - Strengthen policy tools to address financial stability consequences of stress in nonbank financial intermediaries, including the use of liquidity management tools by open-end funds to mitigate systemic impact from abrupt outflows.
  - Strengthen crisis preparedness and management frameworks to deal with potential financial instability from escalation of geopolitical tensions.
  - Continue efforts to deepen and develop financial markets in emerging market and developing economies and accompany developments with robust regulatory frameworks (including clear guidelines for the use of derivatives and other financial instruments).
  - Maintain adequate fiscal policy space and international reserves; contain fiscal vulnerabilities to limit amplifying effects of high public debt on sovereign borrowing costs and manage risks from potential capital flow volatility in line with the IMF’s Integrated Policy Framework.

*International Monetary Fund | April 2025*

### Box 2.1. Tail Risks to Stock Market Returns Amid Global Geopolitical Risks

### Box 2.1. Tail Risks to Stock Market Returns Amid Global Geopolitical Risks

### Key concept and measurement
- The box assesses the impact of a two-standard-deviation increase in the (log) global geopolitical risk index on cumulative stock returns 1, 3, 6, and 12 months ahead.
- The analysis separates results for advanced economies (AEs) and emerging markets (EMs).
- The figure reports outcomes in percentage points and displays 95 percent confidence intervals around estimates.
- Data sources used: Federal Reserve Bank of St. Louis, Federal Reserve Economic Data; Haver Analytics; LSEG Datastream; Organisation for Economic Co-operation and Development, Main Economic Indicators database; IMF, Global Data Source and International Financial Statistics databases; and IMF staff calculations.

### Main empirical finding (framework)
- A substantial increase in global geopolitical risk (two-standard-deviation rise in the log index) is used to quantify downside risk to future cumulative stock returns at horizons of 1 month, 3 months, 6 months, and 12 months.
- Results are presented separately for AEs and EMs to capture heterogeneous exposures and transmission.

### Statistical presentation
- Outcomes are expressed in percentage points for cumulative stock returns at the specified horizons (1-month, 3-month, 6-month, 12-month).
- Shaded areas in the figure indicate the 95 percent confidence interval for each horizon and economy group (AEs and EMs).

### Interpretation and implications
- The exercise quantifies tail downside risk from geopolitical risk shocks to stock market returns across short- and medium-term horizons.
- Disaggregating by AEs and EMs allows identification of differences in sensitivity to global geopolitical risk, informing risk management and portfolio allocation considerations.

*Source: Box 2.1, Chapter 2, GLOBAL FINANCIAL STABILITY REPORT, April 2025.*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2025/april/english/ch2.pdf_