Оценка влияния геополитического риска на рынки облигаций европейских стран / The impact of geopolitical risk on bond markets of European countries
Аннотация
For many decades, geopolitical events have been one of the most important determinants of financial market movements. Typically, escalating military conflicts, terrorist attacks and other geopolitical risks lead to panic among investors and traders, forcing them to switch from risky investment to safer assets, which are regarded as «safe havens». Usually this effect is also evident for sovereign bonds which provide governments with an opportunity to execute expansionary fiscal policy, finance social programs and infrastructure projects, including green initiatives.
The global geopolitical risk index has consistently remained high since the onset of the Russia-Ukraine conflict in 2022. This geopolitical shock has had a significant impact on the European financial system, particularly due to the proximity of European countries to the conflict zone. Moreover, these countries still take part in the conflict by implementing sanctions and providing military support to Ukrainian troops in an attempt to counter the actions of the Russian side. Consequently, this study's relevance is based on the fact that geopolitical risk will likely remain a crucial factor in the pricing of European financial markets for the foreseeable future. Additionally, being exposed to geopolitical risks will likely affect investments in European sustainable projects which are commonly financed by issuing green bonds. Therefore, it is highly important for economic and political agents to understand the impact of geopolitical instability on the most significant and liquid financial market – the market of sovereign bonds.
Moreover, conducting this research was motivated by filling in a huge scientific gap as there are few studies examining the link between geopolitical risks and sovereign bond markets. Mostly, the authors apply time-series methods that have several limitations, while in this work cross-quantilogram approach, which has more advantages, will be employed.
The main purpose of this study is to evaluate how geopolitical risks and acts affect sovereign bond returns in seven Eurozone countries, including core (Germany, France, Belgium, Netherlands) and periphery (Spain, Italy, Portugal) economies. In order to achieve the goal, some tasks were accomplished:
- analyze the main characteristics of bonds as a fixed-income investment instrument;
- investigate the main features and historical events that happened on the european bond markets;
- make an overview of previous studies devoted to assessing the impact of geopolitical factors on financial markets, including sovereign bonds;
- determine the most appropriate method for estimating how geopolitical factors affect Eurozone bond markets;
- make an econometric analysis of the link between geopolitical risk indicators and Eurozone bond returns by using a cross-quantilogram approach;
- provide final conclusions with interpretation of received results, policy implications and possible opportunities to enhance further research in this area.
The object of the study can be considered the market of sovereign bonds in the member states of the Eurozone, while the subject of the study is the impact of geopolitical risks and shocks, such as wars, terrorist attacks, sanctions, etc. on the market of these debt instruments.
In the practical part the cross-quantilogram approach developed by H. Han et al. was used as the main econometric method, which is able to identify nonlinear interdependence between two time series at various conditional quantile levels and examine how one market responds to fluctuations in another market across multiple quantiles and market conditions, including the extreme ones.
The practical relevance of the study lies in the fact that the results of the analysis give a valuable information on the relationship between geopolitical risks and sovereign bond markets. These findings are of interest to European governments and private and institutional investors. For governments, understanding how geopolitical decisions can affect bond yields is critical in terms of assessing debt burden and making decisions about future debt market borrowings. For investors, the conclusions of this paper can serve as a basis for making decisions about hedging geopolitical risks in their portfolios where European sovereign bonds are included. They can do it by purchasing green bonds, which sometimes show an evidence of «safe haven» effect, according to several studies.
The final results indicate that global geopolitical risk has a negative effect on the periphery countries as well as on the core Eurozone economies during the bullish phases of market returns, when sovereign bond prices grow rapidly. However, positive spillovers from geopolitical risk index to bond returns were observed in 5 counties probably because of attractive bond yields and investors’ anticipation of prices appreciate in the future. The study also highlights that global geopolitical acts as the most severe events on a geopolitical field have a strongly negative impact on all countries in the sample, regardless of their core or periphery status.
Regarding the analysis of the link between global geopolitical risk and sovereign bond markets in the core Eurozone economies there are different patterns in the behavior of investors in countries. In Germany and the Netherlands, geopolitical risks of any scale had a negative impact on bond returns, leading investors to sell off these assets during periods of market overheating. In contrast, countries like France and Belgium exhibited a similar effect, but complemented by the fact that during market downturns – bearish stages – geopolitical risk movements convinced investors to buy debt instruments, considering them more attractive for speculation, because they are offering higher yields compared to Germany and the Netherlands.
Similarly, in the peripheral countries of the Eurozone, geopolitical risks had a positive impact on bond returns during significant market declines, as investors sought higher yields and anticipated price increases after geopolitical uncertainty decreased. However, when bond prices reached high levels, investors sold off these securities in response to any active geopolitical trigger.
Examining the impact of geopolitical acts on sovereign bond markets revealed consistent negative effects in both core and peripheral Eurozone countries. Despite the strong economies and financial systems in the core countries, there was no «safe haven» effect as investors experienced panic and sold off their securities during periods of escalating conflicts or terrorist attacks, especially when prices were in an active rising phase. It means they were looking for other assets to invest or simply held cash until panic on the markets is decelerated.
Overall, the study demonstrates that geopolitical risks and acts predominantly have a negative effect on bond returns in the Eurozone countries, particularly during bullish market stages. There is no evidence of a «safe haven» effect in any country, even though in some cases results showed that during the extremely bearish conditions investors purchased the assets with historically higher bond yields, but then sold them off when prices have grown. Furthermore, the study highlights the significant integration of European financial markets, as there were minimal differences in investors' behavior and perception of geopolitical risks and acts across different Eurozone bond markets.
The global geopolitical risk index has consistently remained high since the onset of the Russia-Ukraine conflict in 2022. This geopolitical shock has had a significant impact on the European financial system, particularly due to the proximity of European countries to the conflict zone. Moreover, these countries still take part in the conflict by implementing sanctions and providing military support to Ukrainian troops in an attempt to counter the actions of the Russian side. Consequently, this study's relevance is based on the fact that geopolitical risk will likely remain a crucial factor in the pricing of European financial markets for the foreseeable future. Additionally, being exposed to geopolitical risks will likely affect investments in European sustainable projects which are commonly financed by issuing green bonds. Therefore, it is highly important for economic and political agents to understand the impact of geopolitical instability on the most significant and liquid financial market – the market of sovereign bonds.
Moreover, conducting this research was motivated by filling in a huge scientific gap as there are few studies examining the link between geopolitical risks and sovereign bond markets. Mostly, the authors apply time-series methods that have several limitations, while in this work cross-quantilogram approach, which has more advantages, will be employed.
The main purpose of this study is to evaluate how geopolitical risks and acts affect sovereign bond returns in seven Eurozone countries, including core (Germany, France, Belgium, Netherlands) and periphery (Spain, Italy, Portugal) economies. In order to achieve the goal, some tasks were accomplished:
- analyze the main characteristics of bonds as a fixed-income investment instrument;
- investigate the main features and historical events that happened on the european bond markets;
- make an overview of previous studies devoted to assessing the impact of geopolitical factors on financial markets, including sovereign bonds;
- determine the most appropriate method for estimating how geopolitical factors affect Eurozone bond markets;
- make an econometric analysis of the link between geopolitical risk indicators and Eurozone bond returns by using a cross-quantilogram approach;
- provide final conclusions with interpretation of received results, policy implications and possible opportunities to enhance further research in this area.
The object of the study can be considered the market of sovereign bonds in the member states of the Eurozone, while the subject of the study is the impact of geopolitical risks and shocks, such as wars, terrorist attacks, sanctions, etc. on the market of these debt instruments.
In the practical part the cross-quantilogram approach developed by H. Han et al. was used as the main econometric method, which is able to identify nonlinear interdependence between two time series at various conditional quantile levels and examine how one market responds to fluctuations in another market across multiple quantiles and market conditions, including the extreme ones.
The practical relevance of the study lies in the fact that the results of the analysis give a valuable information on the relationship between geopolitical risks and sovereign bond markets. These findings are of interest to European governments and private and institutional investors. For governments, understanding how geopolitical decisions can affect bond yields is critical in terms of assessing debt burden and making decisions about future debt market borrowings. For investors, the conclusions of this paper can serve as a basis for making decisions about hedging geopolitical risks in their portfolios where European sovereign bonds are included. They can do it by purchasing green bonds, which sometimes show an evidence of «safe haven» effect, according to several studies.
The final results indicate that global geopolitical risk has a negative effect on the periphery countries as well as on the core Eurozone economies during the bullish phases of market returns, when sovereign bond prices grow rapidly. However, positive spillovers from geopolitical risk index to bond returns were observed in 5 counties probably because of attractive bond yields and investors’ anticipation of prices appreciate in the future. The study also highlights that global geopolitical acts as the most severe events on a geopolitical field have a strongly negative impact on all countries in the sample, regardless of their core or periphery status.
Regarding the analysis of the link between global geopolitical risk and sovereign bond markets in the core Eurozone economies there are different patterns in the behavior of investors in countries. In Germany and the Netherlands, geopolitical risks of any scale had a negative impact on bond returns, leading investors to sell off these assets during periods of market overheating. In contrast, countries like France and Belgium exhibited a similar effect, but complemented by the fact that during market downturns – bearish stages – geopolitical risk movements convinced investors to buy debt instruments, considering them more attractive for speculation, because they are offering higher yields compared to Germany and the Netherlands.
Similarly, in the peripheral countries of the Eurozone, geopolitical risks had a positive impact on bond returns during significant market declines, as investors sought higher yields and anticipated price increases after geopolitical uncertainty decreased. However, when bond prices reached high levels, investors sold off these securities in response to any active geopolitical trigger.
Examining the impact of geopolitical acts on sovereign bond markets revealed consistent negative effects in both core and peripheral Eurozone countries. Despite the strong economies and financial systems in the core countries, there was no «safe haven» effect as investors experienced panic and sold off their securities during periods of escalating conflicts or terrorist attacks, especially when prices were in an active rising phase. It means they were looking for other assets to invest or simply held cash until panic on the markets is decelerated.
Overall, the study demonstrates that geopolitical risks and acts predominantly have a negative effect on bond returns in the Eurozone countries, particularly during bullish market stages. There is no evidence of a «safe haven» effect in any country, even though in some cases results showed that during the extremely bearish conditions investors purchased the assets with historically higher bond yields, but then sold them off when prices have grown. Furthermore, the study highlights the significant integration of European financial markets, as there were minimal differences in investors' behavior and perception of geopolitical risks and acts across different Eurozone bond markets.