Dynamic spillover between geopolitical risk and energy markets: Portfolio hedging implication

Given the intensification of geopolitical tensions that has repeatedly triggered energy supply disruptions, the risk spillovers between geopolitical risk (GPR) and the global energy market were widely explored, yet often relies on dimensionally constrained models that fail to capture the complex risk connectivity. In this paper, we develop a high-dimensional time-varying parameter vector autoregressive spillover (HD-TVP-VAR) model to overcome the dimensionality curse and information loss inherent in traditional spillover models to examine the intricate time-varying risk contagion, and the dynamic risk spillover of GPR on various countries' energy markets from January 2, 2006, to February 28, 2025. GPR exhibits heterogeneous risk spillover effects on various countries' energy markets, with Norway, Australia, Austria, and Poland experiencing relatively higher spillovers, while Italy, South Africa, and Thailand are subject to lower degrees of GPR-induced risk spillover. Notably, the United States may play a role as a GPR transmitter. Both the total risk connectivity of GPR with the global energy market and the dynamic risk spillovers from GPR to the energy markets of individual countries exhibit pronounced time-varying characteristics. Additionally, the minimum connectedness portfolio (MPC) outperforms other portfolio approaches in return performance. These results offer key references for policymakers to develop a macroprudential risk framework and investors to optimize portfolios.