The term "Geo-political Risks (GPRs)" recently caught the attention of researchers and academicians studying the volatility of the stock market in different countries.
After a plethora of previous studies found the impact of historical events – especially the geopolitical ones – on asset prices, the effect of geopolitical crises on stock market volatility has become an emerging issue.
Geopolitical risks, otherwise known as the risks arising from political tensions such as terrorism, riots and wars, evidently affect the business cycles and financial markets of many economies in the world.
Besides, GPRs can influence the stock market in many ways. For instance, increasing geopolitical tensions can easily persuade the market stakeholders' decision to adjust and rebalance portfolios by buying and selling stocks. GPRs also evidently hurt investment decisions in the global financial market.
A research study has revealed that while the country-specific geopolitical risks do not have a significant impact on stock market returns, global geopolitical events had a stronger impact on stock market volatilities of 18 emerging economies from 1998 to 2017.
Moreover, geopolitical risks were found to have a significant impact on stock market volatility measures in BRICS nations. Furthermore, evidence shows that geopolitical events from various countries, except for some emerging economies, significantly affect the stock market volatility of the Chinese stock market.
The events and its effects
The researchers have found a positive causal relationship between the press releases regarding the US-China trade war and the co-movement of the US and Chinese stock market, by applying the event analysis method, using daily data from 2017 to 2020.
While Brexit has been affecting the European stock markets for years, its impact on the financial markets of other countries has slowed down recently.
The Covid-19 pandemic had adverse but short-term effects on the stock markets of the global economies, resulting in trillions of dollars of losses worldwide. Moreover, the most recent Russian-Ukrainian conflict has adversely affected the financial markets of approximately 40 economies in the world. It has increased the stock market volatility of the European countries due to their geographical proximity and due to their energy dependence on Russia.
Although the Bangladeshi stock market moves in an isolated manner and is not proven to be co-integrated with the global crises and co-movements of international stocks, the Covid-19 pandemic affected the Dhaka stock market unfavourably. For instance, from February 2020 to June 2020, the total market value of the stocks declined by 11.5% followed by a rise in the daily stock volatility of 2.2%.
Furthermore, even though not directly correlated, the stock market of Bangladesh may experience some indirect spillover effects in terms of volatility due to the geopolitical incidents taking place across the world. Therefore, this paper attempts to investigate whether there are any effects of major geopolitical crises on Dhaka stock market volatility.
To estimate the impact of geopolitical events on Dhaka stock market volatility, major global geopolitical events from 2013 to 2022 have been taken into consideration such as Brexit, the Covid-19 pandemic, the Russia-Ukraine War, the US intervention in the Syrian civil war and US-China trade war.
Since domestic factors influence stock market movements, this study has included industrial production growth rate, exchange rate and inflation rate as control variables from February 2013 to March 2022 based on previous literature.
Hence, the estimation could provide a true picture of the effects of geopolitical events on the stock market volatility in Bangladesh. The monthly data for the exchange rate, industrial production and inflation rate have been collected from the website of Bangladesh Bank and Asia Regional Integration Centre (ARIC).
As the variables are stationary, multiple OLS regressions were run on the time series data set. Although the R-squares of models are low, all the models are statistically significant at a 5% level. In model-2, the covid-19 pandemic significantly affects the volatility of the Dhaka stock exchange market and it was expected.
The US-China trade war has a significant impact on the Dhaka stock exchange volatility according to the fourth model. The sixth model, which includes all the events considered, is overall statistically significant. While the positive coefficients of the dummy coded variables i.e. Brexit and Covid-19 pandemic imply statistically significant results, those of other events such as the Russia-Ukraine crisis and US-led intervention in the Syrian civil war are not statistically significant at the 5% level.
The results depict that the statistically significant coefficient events stimulate higher volatilities in the Dhaka stock market returns, compared to that during the absence of the specified events.
In addition, as expected, the domestic macroeconomic factors' effect has some influence on stock market volatilities. An increase in the monthly inflation rate and industrial production growth rate leads to an increase in the Dhaka stock market volatility. However, a decrease in the exchange rate, meaning an appreciation of the currency, leads to an increase in volatility and vice-versa.
Therefore, aligned with the prior expectations, the stock market prices are highly volatile during the overlap of the three events. In addition, the results indicate a significant impact of the US-China trade war, Brexit and Covid-19 pandemic on the volatility of Dhaka stock market prices in different models.
The underlying reasons may be the political relations and trade-related engagement of Bangladesh with the United States, the United Kingdom and China. Moreover, due to the global unrest caused by the Covid-19 pandemic, the world stock markets, including Dhaka, have shown volatile nature as a consequence of the panicked buying and selling of stocks.
On the other hand, the other events such as the US-led intervention in the Syrian civil war and the Russian-Ukrainian crisis do not significantly affect the stock market volatility of Dhaka stock prices.
While the Syrian civil war did not have any significant impact on DSEX due to low trade exchange, the Russia-Ukrainian conflict is supposed to have some impact on DSEX due to Bangladesh's trade engagement with Ukraine, where the balance of trade in 2021 was $166 million in imports in Bangladesh.
This anomaly is due to a low number of observations compared to the entire dataset as the crisis has begun very recently. Nevertheless, geopolitical crises are unpredictable and can increase the volatility of the stock market of Bangladesh as a spillover effect.
Figure-2 indicates that higher volatility in stock prices is on average compensated with a higher return. But this may vary depending on different sets of portfolios of different investors.
While higher volatility indicates higher risk for the investors due to frequent fluctuation of the stock prices, it does not necessarily mean that the risk would always prevail in the long run even after the geopolitical crises have ended. In times like these, panicked trading of stocks is not a solution.
Instead of selling the stocks, not paying attention to the short-term fluctuations and holding the stock for a long time can be a reliable option for long-term investment.
On the other hand, for investors who are looking to buy stocks, a volatile stock market may create a good opportunity to purchase the stock at a lower price if the orders are placed at the right moment. Regardless, investors should be aware of major geopolitical events that can cause a potential impact on the stock market and strategise their decisions of investment accordingly.
The author is Research Associate at BRAC Business School's Research and Professional Development Centres (RPDCs).
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.