The Impact of Geopolitical Risk on Stock Market Volatility and Returns: Evidence from Southeast Asia

Abstract

This study investigates the impact of geopolitical risk (GPR) on stock market volatility and returns across six Southeast Asian countries. The motivation stems from the increasing frequency and severity of geopolitical events in recent years, particularly as emerging economies remain highly vulnerable to external shocks. Employing a panel vector autoregression model with exogenous variables (P-VARX), the analysis reveals that market volatility exhibits strong persistence, consistent with the well-documented phenomenon of volatility clustering in the financial literature. Contrary to much of the existing evidence from developed markets, the findings suggest that past geopolitical shocks tend to dampen current market volatility, reflecting a swift adjustment mechanism among investors in Southeast Asia. Furthermore, GPR exerts a positive influence on future stock returns. Impulse response functions and forecast error variance decompositions further elucidate the dynamic and asymmetric relationship between volatility and returns over time. These results offer novel empirical insights, indicating that while Southeast Asian markets are susceptible to geopolitical disturbances, they also demonstrate a remarkable capacity to absorb shocks and recover promptly. The study provides valuable implications for investors and policymakers in formulating effective risk management and investment strategies amidst rising global uncertainties.