Investor Trading Behavior Around the Time of Geopolitical Risk Events: Evidence from South Korea

How do investors respond to geopolitical risk events? The South Korean stock market gives an interesting testing ground because the nuclear weapons testing and military aggressions by its belligerent neighboring country, North Korea, are exogenous. Moreover, as North Korea has transitioned from a state without nuclear weapons to one with substantial nuclear capabilities, investors have revised their beliefs about the level of geopolitical risk with each weapons test. Using Korean microstructure data from 1999 to 2012, we find a permanent negative abnormal return of -1.6% in the South Korean market (and -0.88% for the US market) for nuclear weapons testing, but do not find significant return for military attacks. Bid-ask spread analysis indicates significant increases in information asymmetry among investors before these events. Moreover, we find a significant spike in abnormal short selling volume before the events.