Stocks|Lähi-Tapiola’s chief economist examined the effect of the geopolitical risk index based on newspaper articles on the stock market and noticed that the mere threat of a crisis is enough to move the market.
The summary is made by artificial intelligence and checked by a human.
Geopolitical risks affect the stock market in the short term, says Lähi-Tapiola’s Chief Economist Jari Järvinen.
The risk index predicts the development of the stock market over a period of a few months.
The results of the analysis can help investors with a shorter investment horizon to benefit from the market’s overreaction.
Is that enough? mere coverage of geopolitical risks to sway the stock market?
Insurance company Lähi-Tapiola Chief Economist and Director of Asset Management Jari Järvinen says yes enough.
Järvinen compared researchers on the payroll of the US central bank, the Fed Dario Caldaran and Matteo Iacovello developed geopolitical risk indicator to stock market development and found that in the short term, news about geopolitical risks is reflected in stock prices.
Caldara and Iacovello’s risk index examines the number of articles dealing with geopolitical tensions in major English-language newspapers since 1900.
Järvinen examined the risk index and the development of the world’s most followed stock index, the S&P 500, using the Granger causality test used in statistics throughout the indicator’s entire 120-year period, but also over shorter periods.
Based on the test, changes in the number of articles dealing with geopolitical tensions predicted the performance of the stock market, but only over a period of a few months.
According to the data, when the risk index was high, the stock market typically weakened, and when the index was low, the stock market was typically high.
In the longer term, the effect dissipated.
Lähi-Tapiola’s Chief Economist and Director Jari Järvinen.
Järvinen the method used means that news about geopolitical risks on the pages of major English-language newspapers is enough to influence the market.
“When geopolitics is written and talked about, there are threats, realizations and escalations. There is a threat [osakemarkkinoiden näkökulmasta] just as impressive a factor as what happens and is realized afterwards.”
According to Järvinen, the results of the analysis can give investors with a shorter investment horizon the opportunity to benefit from the market’s overreaction.
“With a time span of about four months, the results are relevant for investors who want to use it for shorter trading. If you are a long-term investor, the effects subside very quickly and are no longer significant,” says Järvinen.
Risk index according to Järvinen, interesting moments were found in the material covering more than 120 years.
For example, during the Second World War, a risk indicator based on newspaper articles not only predicted the development of the stock market, but the stock market also predicted the movements of the index.
“That’s quite understandable. When we live in wartime, then of course the world is full of geopolitics and the market works inefficiently even at that stage”, Järvinen estimates.
In the happy 1920s and the depression of the 1930s, Järvinen discovered that the financial market had predictive power.
“[Rahoitusmarkkinat] as if smelling these future geopolitical tensions.”
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“There is a threat [osakemarkkinoiden näkökulmasta] just as impressive a factor as what happens and is realized afterwards.”
Another in the period of reconstruction after World War until the beginning of the 70s, Järvinen did not observe statistically significant effects between the data sets he examined.
After 2016, however, their connection has strengthened. Järvinen mentions at least Donald Trump’s the election for the US president and Britain’s exit from the euro, i.e. Brexit.
“That is understandable. Trump brought a trade war and other economic sanctions. We are talking about the forces of the geoeconomy, which are now raging.”
According to Järvinen, in the time after Trump’s election, it is statistically even more likely that geopolitical tensions will affect stock exchange rates over a period of a few months.
“The probability of making a mistake is less than one percent. Of course, you can’t be completely sure when you’re talking about statistical testing, but you can already say with pretty good confidence that geopolitics will affect the financial markets in the short term.”
Completely the infallible analysis model used by Järvinen is naturally not. In Caldara and Iacovello’s country-specific risk index, Finland’s geopolitical risks seemed to increase in 2018, when US President Trump and the Russian President Vladimir Putin met in Helsinki.
“Finland’s geopolitical risk index rose because a lot was written about the summit worldwide. We didn’t have any real situation then. It was perhaps a false risk when it was written about,” says Järvinen.
On the other hand, Russia’s attack on Ukraine was also reflected in Finland’s country-specific risk index.
“And that was a very real threat. These [virheellisiä riskejä] it hurts, but not so much that it destroys the statistical predictive power for the entire period.”
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