measuring geopolitical risk dario caldara matteo iacoviello site

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello Federal Reserve Board DIW Berlin November 3, 2017 Disclaimer: The views expressed are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System.

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Page 1: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Measuring Geopolitical Risk

Dario Caldara Matteo Iacoviello

Federal Reserve Board

DIW BerlinNovember 3, 2017

Disclaimer: The views expressed are solely the responsibility of the authors and should not be interpreted as reflecting the

views of the Board of Governors of the Federal Reserve System or of anyone else associated with the Federal Reserve System.

Page 2: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Risks Receive a Lot of Attention

Geopolitical Risks are often cited by policy-makers, investors, and media askey determinants of economic decisions.

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

But their Impact is Unclear

Little research devoted to quantify geopolitical risks.

Little research devoted to measure macroeconomic and financialimpact of geopolitical risks.

Many empires of the past, from the Roman empire to China’s Qingdinasty, were brought down by a combination of adverse geopoliticalevents.

The economies of many countries (Syria, Libya, Yemen, Venezuela)have collapsed in recent years following wars and political unrest.

Page 4: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Relationship to the Literature on Uncertainty

Recent research effort devoted to understand effects ofmacroeconomic uncertainty.

Most proxies for uncertainty are based/related to economic andfinancial indicators (EPU, VIX, IVOL, RVOL, JLN, ...)

I Endogeneity of these proxies.

Events captured by our index are more exogenous to themacroeconomy than those captured by other uncertainty proxies.

Periods of high uncertainty often result of shocks to first and higherorder moments.

I We distinguish between geopolitical acts and threats.

Page 5: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Our Questions

1. How can we measure geopolitical risk?

Available indices not very amenable to empirical analysis:I Capture very different events;

I Constructed judgmentally;

I Little variation or short sample availability; Examples

I Constructed as combinations of outcome variables(gold, VIX, dollar, oil prices).

2. What are the real and financial effects of geopolitical risk?

Page 6: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Definition of Geopolitical Risk

Geopolitical risk is not a well-defined concept.

We define geopolitical risk as the risk associated with wars, tensionsbetween states, and terrorist acts that affect the normal course ofinternational relations.

Definition follows most common (and journalistic) usage, but leavesroom for some judgement.

It helps excluding some geopolitical phenomena:

I Major economic crisis (e.g. Eurozone debt crisis)

I Major democratic political events (e.g. Brexit)

I Climate change, civil right movements, domestic terrorist acts...

Page 7: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Methodology

Our methodology follows Baker, Bloom, Davis (2016).

We construct the geopolitical risk (GPR) index counting in 11international newspapers the share of articles mentioning phrasesrelated to geopolitical tensions.

Benchmark index (from 1985):

I U.S.: Boston Globe; Chicago Tribune; LA Times; NYT; WSJ; WaPo.

I United Kingdom: Daily Telegraph; FT; Guardian; Times.

I Canada: The Globe and Mail.

Historical index (from 1899): NYT, Chicago Tribune, and FT

GPR as covered by the English-speaking press.

More weight to events with U.S. involvement.

Page 8: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

MeasurementNot as Simple as Searching for ’Geopolitical’ AND ’Risks’

Language has changed:I Term ”Geopolitical risk” popular after 9/11I ”War risks” used to be ”War perils”I ”Terror Threats” used to be ”Terrorist Menaces”

News articles content has changed:I Focus shifted from ’chronicles’ to ’opinions’.

Nature of risks has changed:I From wars to nuclear threats to terrorism.

We choose search categories through an auditing process andrefinements using machine-learning algorithms.

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

MeasurementBuilding the Search Terms

We define 6 search categories based on pilot (stage 1) auditing ofarticles likely mentioning geopolitical risks.

Audit GP set containing Geopolitics or War or Military orTerrorism/t – most RECURRING WORDS in geopolitics books.

In 2,500 articles in GP set, 35% discuss high geopolitical risk(GP = 1).

Most articles in GP = 1 contain additional words related to risks orthreats, tensions between states, beginning of wars.

Construct search categories based on CONTENT OF ARTICLES in GP = 1.

Exclude from searches phrases overwhelmingly associated with falsepositives (GP = 0) (e.g. movie, museum, anniversary, memorial,obituary, ”end of the war”).

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Search TermsSearch Category Words

1. GeopoliticalThreats

Geopolitical AND (risk* OR concern* OR tension* OR uncertaint*)

”United States” AND tensions AND (military OR war OR geopolitical OR coupOR guerrilla OR warfare) AND (”Latin America” OR ”Central America” OR”South America” OR Europe OR Africa OR ”Middle East” OR ”Far East” ORAsia)

2. NuclearThreats

(”nuclear war” OR ”atomic war” OR ”nuclear conflict” OR ”atomic conflict” OR”nuclear missile*”) AND (fear* OR threat* OR risk* OR peril* OR menace*)

3. War Threats”war risk*” OR ”risk* of war” OR ”fear of war” OR ”war fear*” OR ”militarythreat*” OR ”war threat*” OR ”threat of war”

(”military action” OR ”military operation” OR ”military force”) AND (risk* ORthreat*)

4. TerroristThreats

”terrorist threat” OR ”terrorist threats” OR ”menace of terrorism” OR ”terrorismmenace” OR ”threat of terrorism” OR ”terrorist risk” OR ”terror risk” OR ”riskof terrorism” OR ”terror threat” OR ”terror threats”

5. War Acts (beginning OR outbreak OR onset OR escalation OR start) ”of the war”

(war OR military) AND (”air strike” OR ”heavy casualties”)

6. Terrorist Acts ”terrorist act” OR ”terrorist acts”

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Search WordsSearch Category Words

1. GeopoliticalThreats

Geopolitical AND (risk* OR concern* OR tension* OR uncertaint*)

”United States” AND tensions AND (military OR war OR geopolitical OR coupOR guerrilla OR warfare) AND (”Latin America” OR ”Central America” OR”South America” OR Europe OR Africa OR ”Middle East” OR ”Far East” ORAsia)

2. NuclearThreats

(”nuclear war” OR ”atomic war” OR ”nuclear conflict” OR ”atomic conflict” OR”nuclear missile*”) AND (fear* OR threat* OR risk* OR peril* OR menace*)

3. War Threats”war risk*” OR ”risk* of war” OR ”fear of war” OR ”war fear*” OR ”militarythreat*” OR ”war threat*” OR ”threat of war”

(”military action” OR ”military operation” OR ”military force”) AND (risk* ORthreat*)

4. TerroristThreats

”terrorist threat” OR ”terrorist threats” OR ”menace of terrorism” OR ”terrorismmenace” OR ”threat of terrorism” OR ”terrorist risk” OR ”terror risk” OR ”riskof terrorism” OR ”terror threat” OR ”terror threats”

5. War Acts (beginning OR outbreak OR onset OR escalation OR start) ”of the war”

(war OR military) AND (”air strike” OR ”heavy casualties”)

6. Terrorist Acts ”terrorist act” OR ”terrorist acts”

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Search WordsSearch Category Words

1. GeopoliticalThreats

Geopolitical AND (risk* OR concern* OR tension* OR uncertaint*)

”United States” AND tensions AND (military OR war OR geopolitical OR coupOR guerrilla OR warfare) AND (”Latin America” OR ”Central America” OR”South America” OR Europe OR Africa OR ”Middle East” OR ”Far East” ORAsia)

2. NuclearThreats

(”nuclear war” OR ”atomic war” OR ”nuclear conflict” OR ”atomic conflict” OR”nuclear missile*”) AND (fear* OR threat* OR risk* OR peril* OR menace*)

3. War Threats”war risk*” OR ”risk* of war” OR ”fear of war” OR ”war fear*” OR ”militarythreat*” OR ”war threat*” OR ”threat of war”

(”military action” OR ”military operation” OR ”military force”) AND (risk* ORthreat*)

4. TerroristThreats

”terrorist threat” OR ”terrorist threats” OR ”menace of terrorism” OR ”terrorismmenace” OR ”threat of terrorism” OR ”terrorist risk” OR ”terror risk” OR ”riskof terrorism” OR ”terror threat” OR ”terror threats”

5. War Acts (beginning OR outbreak OR onset OR escalation OR start) ”of the war”

(war OR military) AND (”air strike” OR ”heavy casualties”)

6. Terrorist Acts ”terrorist act” OR ”terrorist acts”

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Search WordsSearch Category Words

1. GeopoliticalThreats

Geopolitical AND (risk* OR concern* OR tension* OR uncertaint*)

”United States” AND tensions AND (military OR war OR geopolitical OR coupOR guerrilla OR warfare) AND (”Latin America” OR ”Central America” OR”South America” OR Europe OR Africa OR ”Middle East” OR ”Far East” ORAsia)

2. NuclearThreats

(”nuclear war” OR ”atomic war” OR ”nuclear conflict” OR ”atomic conflict” OR”nuclear missile*”) AND (fear* OR threat* OR risk* OR peril* OR menace*)

3. War Threats”war risk*” OR ”risk* of war” OR ”fear of war” OR ”war fear*” OR ”militarythreat*” OR ”war threat*” OR ”threat of war”

(”military action” OR ”military operation” OR ”military force”) AND (risk* ORthreat*)

4. TerroristThreats

”terrorist threat” OR ”terrorist threats” OR ”menace of terrorism” OR ”terrorismmenace” OR ”threat of terrorism” OR ”terrorist risk” OR ”terror risk” OR ”riskof terrorism” OR ”terror threat” OR ”terror threats”

5. War Acts (beginning OR outbreak OR onset OR escalation OR start) ”of the war”

(war OR military) AND (”air strike” OR ”heavy casualties”)

6. Terrorist Acts ”terrorist act” OR ”terrorist acts”

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Benchmark Geopolitical Risk Index

0

100

200

300

400

500

600

1985 1990 1995 2000 2005 2010 2015

GPR Benchmark Index (GPR)Index (2000-2009 = 100)

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Benchmark Geopolitical Risk Index

0

100

200

300

400

500

600

1985 1990 1995 2000 2005 2010 2015

GPR Benchmark Index (GPR)Index (2000-2009 = 100)

TWA Hijacking

US bombs Libya

US Invasion of Panama

Kuwait Invasion

Gulf War

Iraq Disarmament Crisis 1998

9/11

Iraq invasion

Madrid bombings

London bombings

Iran/Nuclear Tensions

Arab Spring: Syrian & Lybian

War

Syrian Civil War Escalation

Russia annexes Crimea

ISIS Escalation

Paris attacks

https://www2.bc.edu/matteo-iacoviello/gpr.htm

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Threats vs. Geopolitical Acts

GPR index captures a convolution of shocks to first and higher ordermoments of the distribution of geopolitical events.

I Spikes in risk often coincide with realization of big events.

We organize searches to separate threats that do not immediatelymaterialize from acts that reveal an underlying threat.

I Geopolitical Threats (GPT): Search categories 1 to 4;

I Geopolitical Acts (GPA): Search categories 5 to 6.

Page 17: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Threats vs Geopolitical ActsCorrelation coefficient: 0.55

0

100

200

300

400

500

600

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

GPR THREATS AND ACTSIndex (2000-2009 = 100)

GPR Threats GPR Acts

TWA Hijacking

US bombs Libya

US Invasion of Panama

Kuwait Invasion

Gulf War

Iraq Disarmament Crisis 1998

9/11

Iraq invasion

Madrid bombings

London bombings

Iran/Nuclear Tensions

Arab Spring: Syrian & Lybian

War

Syrian Civil War Escalation

Russia annexes Crimea

ISIS Escalation

Paris attacks

Page 18: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Threats vs Acts in 1991 and 2003

0

100

200

300

400

1990 1991

Gulf War

GPR Threats GPR Acts

0

100

200

300

400

500

600

2002 2003

Iraq Invasion

GPR Threats GPR Acts

Page 19: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Auditing: Reading and Manually Coding Articles

Stage 1: Audit pilot sample of 2,500 articles from set GP likelycontaining all articles mentioning geopolitical risk

I Use this audit to refine search terms entering construction of GPR

Stage 2: Audit sample of 2,500 articles from set GPR setI 87% mention high or rising geopolitical tensions.I 4% mention low or decreasing geopolitical tensions.I Correlation between GPR and audited-GPR is 0.98

Stage 3: Audit 6,125 articles ( 50 per quarter) from GP set toconstruct human GPR index

I Code articles as 0/1 according to a 20-page Audit GuideI Correlation between computer-generated GPR index and Human Index

is 84 percent (at quarterly frequency) HUMANINDEX

Audit is a long, tedious and painful process PROCESS .

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Comparison with Human Index

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

500

600

GPR IndexHuman Index

Quarterly Correlation: 0.84 Back

Page 21: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Additional Checks

GPR BROAD: Include words often associated with true positives(e.g. ”military presence” OR ”international terror*”)

GPR NARROW: Exclude words often associated with false positives(e.g. ”death penalty” OR ”supreme court”)

Page 22: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

GPR Robust to Adding/Removing Words

0

500

1000

1500

2000

2500

3000

3500

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

GPR Broad RawTotal Articles

GPR Broad

GPR Benchmark

TWA Hijacking

US bombs Libya

US Invasion of Panama

Kuwait Invasion

Gulf War

Iraq Disarmament Crisis 1998

9/11

Iraq invasion

Madrid bombings

London bombings

Iran/Nuclear Tensions

Arab Spring: Syrian & Lybian

War

Syrian Civil War Escalation

Russia annexes Crimea

ISIS Escalation

Paris attacks

0

500

1000

1500

2000

2500

3000

3500

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

GPR Narrow RawTotal Articles

GPR Narrow

GPR Benchmark

TWA Hijacking

US bombs Libya

US Invasion of Panama

Kuwait Invasion

Gulf War

Iraq Disarmament Crisis 1998

9/11

Iraq invasion

Madrid bombings

London bombings

Iran/Nuclear Tensions

Arab Spring: Syrian & Lybian

War

Syrian Civil War Escalation

Russia annexes Crimea

ISIS Escalation

Paris attacks

Page 23: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Geopolitical Risk Index

0

100

200

300

400

500

600

700

800

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

GPR Historical

Sec

ond

Boe

r W

ar a

nd B

oxer

Reb

ellio

n

Beg

inni

ng o

f Rus

sian

-Jap

anes

e W

ar

Firs

t Bal

kan

War

Beg

ins

WW

1 B

egin

sU

S J

oins

WW

1

Italia

n In

vasi

on o

f Eth

iopi

aH

itler

thre

aten

s C

zech

oslo

vaki

aB

egin

ning

of W

WII

Atta

ck o

n P

earl

Har

bor

Ope

ratio

n G

reen

hous

e

Sec

ond

Tai

wan

Str

ait C

risis

Sov

iet U

nion

Res

umes

Nuc

lear

Tes

ts

Mid

dle

Eas

t Ten

sion

s pr

e-6

Day

War

Vie

tnam

War

: Firs

t Bat

tle o

f Qua

ng T

riY

om K

ippu

r W

ar

Fau

klan

ds W

ar B

egin

sA

ble

Arc

her

83U

S B

ombi

ng o

f Lib

ya

Gul

f War

9/11

Iraq

Inva

sion

Rus

sia

anne

xes

Crim

ea

Page 24: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Index: War Threats

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

GPRWar Threats

Page 25: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Index: War Acts

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

GPRWar Acts

Page 26: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Index: Nuclear Threats

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

GPRNuclear Threats

Page 27: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Index: Terror Threats

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

GPRTerrorist Threats

Page 28: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

The Historical Index: Terror Acts

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

GPRTerrorist Acts

Page 29: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Comparison with Human Index (Historical)

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700

Historical GPR IndexHuman Index

Quarterly Correlation: 0.80

Page 30: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Additional Checks

1. Could you do this with a simple index? No Check1

2. Could you use other available indicators? No Check2

3. Do Economic News affect GPR? No Check3

4. Do Other News affect GPR? No Check4

5. How does it relate to VIX? Check5

6. How does it relate to EPU? Check6

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

1. Comparison, Naive Index

1900 1920 1940 1960 1980 20000

100

200

300

400

500

600

700Historical GPR Index, Comparison (Index: 2000-2009=100)

Historical Index Hist, 4 Words

Naive index uses only: ”war” OR ”terrorism/t” OR ”military” OR”geopolitics” Back

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

2. Comparison, International Crisis Database

1900 1920 1940 1960 1980 20000

100

200

300

400

500

His

toric

al In

dex

(200

0-20

09=

100)

0

2

4

6

8

10

Cris

is C

ount

GPRHICB: Number of International Crisis

Back

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

3. Comparison: GPR No Econ Words

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

500

600GPR NOECON

GPRGPR Excluding Econ Related Terms

Back

Page 34: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

4. Comparison: GPR and Natural Disasters

1985 1990 1995 2000 2005 2010 20150

200

400

600

800

1000

Hur

rican

e K

atrin

a

Lom

a P

rieta

Ear

thqu

ake

Nor

thrid

ge E

arth

quak

e

Indi

an O

cean

Ear

thqu

ake

GPRNatural Disasters Index

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

500

600

GPRGPR Explained by Natural Disasters

Back

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

5. Comparison with the VIX

Back

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

6. Comparison: Economic Policy Uncertainty

0

100

200

300

400

500

600

1985 1990 1995 2000 2005 2010 201550

100

150

200

250

GPR vs EPUGPREPU

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

6. Comparison: Economic Policy Uncertainty

GPR vs EPU EPU GPR

1985 1990 1995 2000 2005 2010 2015

0

100

200

300

400

500

600

50

100

150

200

250 US bombs Libya

Kuwait Invasion Madrid

bombings

London bombings

Transatlantic aircraft plot

Russia annexes Crimea

Ukraine and ISIS Paris

attacks

Black Monday

Gulf War

Clinton Election Russian Crisis/LTCM

Bush Election 9/11

Iraq invasion

Stimulus Debate

Lehman Failure and TARP

Euro Crisis Debt Ceiling Debate Fiscal Cliff

Govt. Shutdown

Back

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Economic Effects of GPR

How could GPR matter?

1. Standard Uncertainty/Macro Channels. Test this using macro VAR.

2. Effects on Capital Flows. Uncertainty could reshuffle portfolios towardssafe havens.

3. Effects on Stock Returns.

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Effects of Higher GPR: A VAR Analysis

Sample: 1985M1 to 2016M12.

US VAR:1. GPR Index;2. Economic Policy Uncertainty;3. 2-Year Treasury Yield;4. US industrial production;5. Oil price;6. S&P 500 Index;7. Industries Excess Return Over S&P 500.

International VARs:1. GPR Index;2. Country/Region ’X’ industrial production;

Identification: GPR Index ordered 1st in Cholesky ordering.

Shock sized to match rise in GPR after major events

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to a GPR ShockEffects on US Economy

0 6 12 18 24

0

50

100

150

GPR Index

0 6 12 18 24-10

0

10

20

30EPU Index

0 6 12 18 24

-5

0

5

10

(%)

Consumer Sentiment

0 6 12 18 24-2

-1.5

-1

-0.5

0

0.5

(%)

Industrial Production

0 6 12 18 24-1

-0.8

-0.6

-0.4

-0.2

0

0.2

(%)

Employment

0 6 12 18 24

-4

-2

0

2

(%)

Gross Trade

0 6 12 18 24-5

0

5

(%)

S&P500

0 6 12 18 24-20

-15

-10

-5

0

5

(%)

Real Oil Price

0 6 12 18 24-40

-20

0

20

40

(BP

S)

2-Year Treas. Yield

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to a GPR ShockExcess Return Over S&P 500 - Selected Industries

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Defense

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Oil

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Aircraft

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Steel Works

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Mining

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Insurance

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Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to a GPR ShockInternational Real Effects

0 6 12 18 24

-2

-1

0

1

2

(%)

World

0 6 12 18 24

-2

-1

0

1

2

(%)

Advanced Economies

0 6 12 18 24

-2

-1

0

1

2

(%)

Emerging Economies

0 6 12 18 24

-2

-1

0

1

2

(%)

Canada

0 6 12 18 24

-2

-1

0

1

2

(%)

United Kingdom

0 6 12 18 24

-2

-1

0

1

2

(%)

Mexico

Page 43: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Effects of Higher GPR: Threats vs Acts

Same VAR as before, replace GPR with GPA and GPT.

Identification: GPA ordered 1st and GPT 2nd in Cholesky ordering.

I GPT shocks do not move GPA on impact.

I GPA shocks move GPT on impact.

Page 44: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to GPA and GPT ShocksEffects on US Uncertainty

0 6 12 18 24

0

50

100

150

200

250

300GPA (Acts) Index

0 6 12 18 24

0

50

100

150

200

250

300GPA (Acts) Index

0 6 12 18 24-50

0

50

100

150

GPT (Threats) Index

0 6 12 18 24-50

0

50

100

150

GPT (Threats) Index

0 6 12 18 24-30

-20

-10

0

10

20

30EPU Index

0 6 12 18 24-30

-20

-10

0

10

20

30EPU Index

GPA Shock

GPT Shock

Page 45: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to GPA and GPT ShocksEffects on US Economy

0 6 12 18 24-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

(%)

Industrial Production

0 6 12 18 24-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

(%)

Industrial Production

0 6 12 18 24-5

0

5

(%)

Gross Trade

0 6 12 18 24-5

0

5

(%)

Gross Trade

0 6 12 18 24

-4

-2

0

2

4

6

(%)

S&P500

0 6 12 18 24

-4

-2

0

2

4

6

(%)

S&P500

GPA Shock

GPT Shock

Page 46: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to GPA and GPT ShocksExcess Return Over S&P 500 - Selected Industries (1)

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Defense

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Defense

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Oil

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Oil

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Aircraft

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Aircraft

GPA Shock

GPT Shock

Page 47: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Impulse Responses to GPA and GPT ShocksExcess Return Over S&P 500 - Selected Industries (2)

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Steel Works

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Steel Works

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Mining

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Mining

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Insurance

0 6 12 18 24

-10

-5

0

5

10

15

(%)

Insurance

GPA Shock

GPT Shock

Page 48: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Risk and Capital Flows

Page 49: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Geopolitical Risk and Stock Returns

Page 50: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Conclusions

We construct a quantitative measure of geopolitical risk

We measure the economic effects of changes in geopolitical risk

GPR index is perhaps more ”exogenous” to economic conditions thanother popular measures of risk and uncertainty.

We are currently working on constructing country-specific GPRindexes.

Page 51: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Available Indices 1: Doomsday Clock

Page 52: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Available Indices 2: Geopolitical Heat Maps

Back

Page 53: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Frequent Unigrams in Flint’s Geopolitics Textbook

geop

olit

stat

e

wor

ld

war

natio

n

terr

or

polit

coun

tri

glob

al

conf

lict

pow

er

boun

dari

code

lead

er

unit0

200

400

600

800

1000

1200

Back

Page 54: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Content of Articles in Pilot Auditing

Scatter plot of the 4 principal components from analysis of the top 50bigrams from 2,500 newspaper abstracts classified as E1.

Back

Page 55: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

What Does GPR Capture?

1985 1990 1995 2000 2005 2010 20150

200

400

600

800

1000

Hur

rican

e K

atrin

a

Lom

a P

rieta

Ear

thqu

ake

Nor

thrid

ge E

arth

quak

e

Indi

an O

cean

Ear

thqu

ake

GPRNatural Disasters Index

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

500

600

GPRGPR Explained by Natural Disasters

Page 56: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

GPR Argentina

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

500

600GPR-ARGENTINA

Cam

po d

e M

ayo

Reb

ellio

n

"9/1

1"

Flu

Pan

dem

ic /

Cop

aF

aukl

and

Ten

sion

sArgentina AND (tensions/risk*/fear/chaos/uncertainty/unrest/violence...)AND (military/war/geopolitical/coup/guerrilla/warfare/army/terrorism)

Page 57: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

GPR Brazil

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

GPR-BRAZIL

"9/1

1" Bra

zil e

lect

s le

ftist

Cur

renc

y W

ar

Page 58: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

GPR China

1985 1990 1995 2000 2005 2010 20150

100

200

300

400

GPR-CHINAT

iana

nmen

Sq.

Pro

test

sLi

Pen

g V

isits

Mos

cow

Mis

sile

Tes

ting

AF

C

Hai

nan

Isla

nd In

cide

nt"9

/11"

Page 59: Measuring Geopolitical Risk Dario Caldara Matteo Iacoviello SITE

Introduction Construction GPR Audit GPRH Comparison Effects Conclusions Appendix GPRC

Human Auditors

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