Series: Working Papers. 2522.
Author: Irma Alonso-Alvarez, Marina Diakonova and Javier J. Pérez.
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Abstract
Geopolitical risks and tensions are nowadays regularly presented by policymakers and analysts as key conditioning factors of economic activity in both the short and the medium-run. Widely accepted operational measures of geopolitical risks tend to be based on counting the number of newspaper articles related to adverse geopolitical events, in particular following the ground-breaking paper of Caldara and Iacoviello (2022) in which they build their Geopolitical Risk (GPR) indexes. In this paper we propose one avenue to make further progress in the measurement of such risks. We provide a decomposition of GPR by exploiting the idea that the geopolitical risks that a country faces can be traced back to the countries or entities that are the source of those risks. In this regard, we exploit the idea that geopolitical risk linked to a specific geography or political entity can be interpreted as a “bilateral GPR”, and that the aggregation of such bilateral GPRs provides a natural way of interpreting the overall GPR index. We show that our indexes add distinct information from the benchmark GPR, and together form a more accurate representation of the geopolitical tensions currently present between the major economies. We also show that the geographical origin of a given GPR shock determines its macroeconomic effect in a given economy (as computed from standard VAR models), both in terms of the intensity of such effect and even its sign (i.e. whether a particular GPR shock causes GDP to increase or decrease).