Geopolitical Risk and Foreign Portfolio Investment: A Tale of Advanced and Emerging Markets

Sangyup Choi and Jiri Havel
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Jiri Havel: University of Rochester

No 2023rwp-221, Working papers from Yonsei University, Yonsei Economics Research Institute

Abstract: We study the influence of local geopolitical risk on U.S. cross-border portfolio investment, covering the period from 1994 to 2021. We uncover significant heterogeneity between advanced and emerging market destinations, revealing that local geopolitical risk exerts a dampening effect on U.S. purchases of bonds and equities solely within emerging markets, while having no discernible impact on advanced markets. We identify poor institutional quality as the primary driver behind the heightened sensitivity of portfolio investment to geopolitical risk in emerging markets, thereby signaling potential implications for financial stability. Moreover, our analysis reveals a noteworthy phenomenon where U.S. investment in emerging market bonds experiences a considerable decline in response to the geopolitical risk within other emerging markets in close geographical proximity, displaying a robust contagion effect. However, such contagions do not manifest in cross-border equity investment. Notably, these contagion effects are observed exclusively among emerging markets, providing valuable insights into investors’ portfolio adjustments in the face of elevated geopolitical risk.

Keywords: Geopolitical risk; Foreign portfolio investment; Emerging markets; Institutional quality; Trilemma; Contagion (search for similar items in EconPapers)
JEL-codes: E44 F21 F51 G11 (search for similar items in EconPapers)
Pages: 42pages
Date: 2023-10
New Economics Papers: this item is included in nep-fdg, nep-ifn, nep-int and nep-rmg
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Journal Article: Geopolitical risk and U.S. foreign portfolio investment: A tale of advanced and emerging markets (2025)
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