Geopolitical crises are unpredictable and could potentially increase the volatility of the Bangladesh stock market through a ripple effect. But there are also other factors at play.
The term “Geopolitical Risks (GPR)” has recently caught the attention of researchers and scholars who study stock market volatility in different countries.
After a plethora of previous studies revealed the impact of historical – especially geopolitical – events on asset prices, the effect of geopolitical crises on stock market volatility has become an emerging issue.
Geopolitical risks, otherwise known as risks arising from political tensions such as terrorism, riots and wars, obviously affect the business cycles and financial markets of many economies around the world.
Also, GPRs can influence the stock market in several ways. For example, increasing geopolitical tensions can easily persuade market participants to adjust and rebalance portfolios by buying and selling stocks. GPRs have also obviously hurt investment decisions in the global financial market.
A study found that while country-specific geopolitical risks do not have a significant impact on stock market returns, global geopolitical events had a stronger impact on stock market volatility in 18 emerging economies from 1998 to 2017. .
Additionally, geopolitical risks were found to have a significant impact on measures of stock market volatility in BRICS countries. In addition, evidence shows that geopolitical events in various countries, except for some emerging economies, significantly affect the stock market volatility of China‘s stock market.
Events and their effects
The researchers found a positive causal relationship between press releases regarding the US-China trade war and the co-movement of US and Chinese stock markets, by applying the event analysis method, using daily data from 2017 to 2020.
While Brexit has affected European stock markets for years, its impact on other countries’ financial markets has recently slowed.
The Covid-19 pandemic has had detrimental but short-term effects on the stock markets of global economies, resulting in billions of dollars in losses worldwide. Moreover, the last Russian-Ukrainian conflict had negative effects on the financial markets of about 40 economies in the world. It has increased the stock market volatility of European countries due to their geographical proximity and their energy dependence on Russia.
Although the Bangladeshi stock market is moving in isolation and there is no evidence that it is co-integrated with global crises and co-movements in international stocks, the Covid-19 pandemic has adversely affected the stock market in Dhaka. For example, from February 2020 to June 2020, the total market value of stocks decreased by 11.5%, followed by an increase in daily stock volatility of 2.2%.
In addition, although not directly correlated, the Bangladesh stock market may experience indirect effects in terms of volatility due to geopolitical incidents occurring around the world. Therefore, this article attempts to determine whether there are any effects of major geopolitical crises on Dhaka stock market volatility.
To estimate the impact of geopolitical events on Dhaka stock market volatility, major global geopolitical events from 2013 to 2022 were taken into consideration such as Brexit, Covid-19 pandemic, Russian-Ukrainian war, American intervention in the Syrian civil war. and the trade war between the United States and China.
Since domestic factors influence stock market movements, this study included industrial production growth rate, exchange rate and inflation rate as control variables from February 2013 to March 2022 based on previous literature.
Therefore, the estimate could provide a true picture of the effects of geopolitical events on stock market volatility in Bangladesh. Monthly data on exchange rate, industrial production and inflation rate were collected from the website of Bangladesh Bank and Asia Regional Integration Center (ARIC).
As the variables are stationary, several OLS regressions were run on the time series dataset. Although the R-squares of the models are small, all models are statistically significant at the 5% level. In model 2, the covid-19 pandemic significantly affects the volatility of the Dhaka stock market and it was expected.
The US-China trade war has a significant impact on Dhaka stock market volatility according to the fourth model. The sixth model, which includes all the events considered, is overall statistically significant. While the positive coefficients of the dummy coded variables, namely Brexit and the Covid-19 pandemic, imply statistically significant results, those of other events such as the Russian-Ukrainian crisis and the US-led intervention in the Syrian Civil War are not statistically significant at the 5% level. level.
The results show that statistically significant coefficient events stimulate higher volatilities in Dhaka stock market returns, compared to those in the absence of the specified events.
Moreover, as expected, the effect of domestic macroeconomic factors has some influence on stock market volatilities. An increase in the monthly inflation rate and industrial production growth rate leads to an increase in volatility in the Dhaka stock market. However, a fall in the exchange rate, i.e. an appreciation of the currency, leads to an increase in volatility and vice versa.
Therefore, consistent with earlier expectations, stock prices are highly volatile when the three events overlap. Moreover, the results indicate a significant impact of US-China trade war, Brexit and Covid-19 pandemic on Dhaka stock price volatility in different models.
The underlying reasons may be Bangladesh’s political relations and commercial engagement with the United States, United Kingdom and China. Moreover, due to the global turmoil caused by the Covid-19 pandemic, global stock markets including Dhaka have shown a volatile nature due to panic buying and selling of stocks.
On the other hand, the other events such as the US-led intervention in the Syrian civil war and the Russian-Ukrainian crisis do not significantly affect the market volatility of Dhaka stock prices.
While the Syrian civil war has not had a significant impact on DSEX due to weak trade, the Russian-Ukrainian conflict is believed to have some impact on DSEX due to Bangladesh’s trade engagement with the country. Ukraine, where the trade balance in 2021 was $166 million. in imports into Bangladesh.
This anomaly is due to a low number of observations compared to the data set because the crisis started very recently. Nevertheless, geopolitical crises are unpredictable and can increase the volatility of the Bangladesh stock market through a ripple effect.
Figure 2 indicates that higher stock price volatility is on average offset by higher return. But this may vary depending on the different sets of portfolios of different investors.
Although higher volatility indicates higher risk for investors due to frequent fluctuations in stock prices, it does not necessarily mean that risk will always prevail in the long term, even after geopolitical crises end. In times like these, panicked stock trading is not a solution.
Instead of selling the stock, ignoring short-term fluctuations and holding the stock for a long time can be a reliable option for long-term investing.
On the other hand, for investors looking to buy stocks, a volatile stock market can create a good opportunity to buy the stock at a lower price if orders are placed at the right time. Either way, investors should be aware of major geopolitical events that can potentially impact the stock market and build their investment strategies accordingly.
Samiha Binte Tariq. Illustration: TBS
Samiha Binte Tariq. Illustration: TBS