The effect of geopolitical risks on stock returns and volatility of European companies

Abstract

This thesis explores the effect of global geopolitical risks (GPRs) on the stock returns and volatility of returns of 1,378 European companies, which have been listed in the STOXX Europe 600 during this century. Using the daily geopolitical risk index constructed by Caldara and Iacoviello (2018), I calculate the individual exposure of each company to the percentage change in the index and, by means of a panel data model with an annual frequency, I find that exposure to geopolitical events affects firm-level stock returns positively, at a ten percent significance level. Volatility also appears to be positively and significantly affected by geopolitical threats, even after controlling for company characteristics and year and country fixed effects. This demonstrates that a specific measure for GPRs should be included in asset pricing and risk management models, as they are an important factor when it comes both to stock returns and volatility.