26 July 2019
Bob Cunneen, Senior Economist and Portfolio Specialist
Sources: ‘Measuring Geopolitical Risk’, Caldara, Dario and Matteo Iacoviello, International Finance Discussion Papers, Board of Governors of the Federal Reserve System, January 2018.
Just like the climate, global political risks seem to be getting warmer these days. Escalating tensions between Iran and the US, Hong Kong’s protests, North Korea’s nuclear ambitions and Syria’s tragic war are all alarming signs. Yet the key challenge for investors is finding an objective measure of political risk amidst this troubling era of ‘fake news’.
A fascinating temperature gauge for measuring political risks comes from a recent calculation by two economists. The Geopolitical Risk (GPR) Index counts how many newspaper articles mention selective words such as “tension”, “threat”, “terrorism” and “war”. The more times these select words are mentioned, the higher the GPR Index rises. Notably the GPR Index has recorded sharp increases around recent major political events such as the September 11 terrorist attacks in 2001, the 2003 Iraq invasion and the 2014 Russia-Ukraine crisis (red line).
The importance of this political risk measure is twofold. Firstly, the historical evidence suggests that global economic growth and share markets are acutely sensitive to political risks. Secondly, the current GPR reading is above average, suggesting that investors need to be cautious. Whether the potential threats with Iran, Hong Kong, North Korea or Russia intensify or some other major political shock occurs is beyond our ability to forecast. However, we cannot dismiss political risks as just ‘fake news’ when this temperature gauge is rising.
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