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When bad news is good news: Geopolitical risk and the cross-section of emerging market stock returns

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  • Zaremba, Adam
  • Cakici, Nusret
  • Demir, Ender
  • Long, Huaigang

Abstract

Using a news-based gauge of geopolitical risk, we study its role in asset pricing in global emerging markets. We find that changes in risk positively predict future stock returns. The countries with the highest increase in geopolitical uncertainty outperform their counterparts with the lowest change by up to 1% per month. The anomaly is not explained by other established asset pricing effects and remains robust to many considerations. We link the observed phenomenon with investor overreaction to geopolitical news driven by the availability bias.

Suggested Citation

  • Zaremba, Adam & Cakici, Nusret & Demir, Ender & Long, Huaigang, 2022. "When bad news is good news: Geopolitical risk and the cross-section of emerging market stock returns," Journal of Financial Stability, Elsevier, vol. 58(C).
    • Handle: RePEc:eee:finsta:v:58:y:2022:i:c:s1572308921001236
    DOI: 10.1016/j.jfs.2021.100964
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    More about this item

    Keywords

    Geopolitical Risk Index; The cross-section of stock returns; Emerging markets; Equity anomalies; Asset pricing; Return predictability; Overreaction; Availability heuristic; Salience;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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