European financial markets, energy returns and geopolitical risk: A frequency domain spectral analysis

The subject of this paper is the complex connections within market uncertainty, geopolitical risk, and returns in the energy sector. Geopolitical risk exerts a significant influence on investor sentiment and portfolio decisions, prompting the need for higher returns to compensate for heightened risk. We examine how geopolitical risks impact European equity returns within the framework of the global energy crisis. The daily data, covering eleven (11) years, namely the period 07/03/2013 -18/03/2024, include returns and volatility data for the energy sector’ and EURO STOXX indices. Employing a Breitung–Candelon frequency domain spectral causality methodology, as well as the Zivot–Andrews structural break test, we scrutinize variations in the influence of uncertainties and of geopolitical risks on the equity returns. Exhaustive analysis based on the COVOL indices and the widely used GPR index, as well as on the Brent crude oil and the natural gas prices confirms our findings’ robustness. In addition, our study incorporates the Energy Security Index (ESI) and the Energy-Related Uncertainty Index (EUI) to further explore the dynamic interdependencies between geopolitical risk and the energy sector. Our analysis illustrates the increased sensitivity of the returns to different geopolitical uncertainties and to changes in the energy sector, but also highlights the need for adaptive strategies, particularly in times of crisis.