Examine why geopolitical risk events worldwide leave different marks on individual countries, industries and asset classes, notably separating net commodity importers from exporters.
The idea
The same geopolitical event does not hit every market equally. The main dividing line is net commodity importers versus net commodity exporters. When an event pushes up energy or food prices, importers suffer a terms-of-trade loss and their equities tend to fall more, while exporters gain income and fall less or even rise. A first-round income effect on a country is roughly the following. Effect = price change × net trade share of GDP. The sign depends on which side the country is on, positive for a net exporter and negative for a net importer. Industries differ too, since energy producers and defense firms usually fare better than airlines or consumer discretionary firms. Safe-haven assets such as gold behave differently from equities. Beware assuming exporters always win, because an event that lowers commodity prices reverses the pattern.
Formulas
First-round income effect of a commodity price change
income effect = ΔP × net exports
- ΔP
- the percentage change in the commodity price
- net exports
- the country's net exports of the commodity as a share of GDP, negative for a net importer
Gives the effect as a share of GDP. The sign flips when prices fall, so exporters do not always gain.
A practice question
Which industry pairing is most consistent with the way a geopolitical shock typically affects sectors?
- Energy producers and defense contractors outperform, while airlines and consumer discretionary firms underperform. - correct
- Airlines and consumer discretionary firms outperform, while energy producers underperform.Why not: Reverses the pattern: airlines face higher fuel costs and weaker demand.
- All industries decline by the same amount, since the shock is systemic.Why not: Denies sector heterogeneity, which is a central finding for these events.
- Utilities and energy producers underperform because of lower commodity prices.Why not: Assumes commodity prices fall; geopolitical shocks usually raise energy prices.
Sector effects follow input costs, demand and price changes. Energy and defense benefit from higher prices and spending, while fuel users and discretionary sectors lose.
A harder one
Country X is a net oil exporter with net oil exports of 8% of GDP. Country Y is a net importer with net oil imports of 3% of GDP. Oil prices rise by 20%. The first-round income effect on Country Y, as a percentage of GDP, is closest to:
- -3.0%Why not: Uses the net import share and forgets to multiply by the 20% price increase.
- +0.6%Why not: Gets the sign wrong, treating the importer as if it gained from the higher price.
- -0.6% - correct
- -23.0%Why not: Adds the 20% price rise to the 3% import share instead of multiplying them.
Income effect = price change x net trade share = 20% x (-3%) = -0.6% of GDP. Country X gains by 20% x 8% = +1.6% of GDP, which is why exporters and importers diverge.
The hardest tier
An analyst regresses country equity returns (in percent) on a geopolitical risk shock measured in standard deviations, with an interaction for net commodity exporters. The coefficient on the shock is -1.2 and the interaction coefficient for exporters is +1.8. For a 2 standard deviation shock, the predicted return of an exporter's equity market is closest to:
- +3.6%Why not: Doubles the interaction coefficient alone and forgets the base effect of -1.2.
- -2.4%Why not: Gives the importer response, omitting the exporter interaction.
- +0.6%Why not: Adds the coefficients correctly but forgets to scale for the 2 standard deviation shock.
- +1.2% - correct
Exporter response per standard deviation = -1.2 + 1.8 = +0.6. For a 2 standard deviation shock: 2 x 0.6 = +1.2%.
In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.
Start free →More in Global Financial Stability Report, Chapter 2
- Pinpoint the main routes by which geopolitical risk moves asset prices and affects financial stability, and review policy responses to its possible fallout.
- Judge how stock markets reacted to various domestic and global geopolitical risk events, such as Russia's invasion of Ukraine and U.S.-China trade tensions, and account for their spillovers across borders.
- Judge the way geopolitical shocks feed into the premiums demanded for holding sovereign risk.
- Show how equity and option markets price in geopolitical risk, including shifts in downside risk and tail-risk premiums.
- Outline how being exposed to geopolitical risk shapes how well banks and non-bank financial firms hold up, through share valuations, credit supply and flows into investment funds.