Geopolitical risks have fallen - Another good sign

There are many types of risks and uncertainties that investors face. Risk and uncertainty are not the same as market volatility. Risk reflects the dispersion in probabilities concerning future events and uncertainty reflects our inability to form probabilities on future events. These are not easy to measure, so investors may have to form proxies. 

There are now different indices for calculating different types of risk. There is the economic policy uncertainty index which focuses on news associated with government fiscal and monetary issues. See the economic policy uncertainty website for more details. There is also geopolitical risk index which focuses on news stories tied to key words like war and terrorism.

The description for the geopolitical risk (GPR) index can be found at the website of Dario Caldara and Matteo Iacoviello, geopolitical risk index. The index is based on text searches of 11 leading newspapers and counts key words and topics associated with geopolitical risk. The topics include: geopolitical risks, nuclear tensions, war threats, terrorists threats, and adverse global events. The text counts are normalized versus a base period and reported monthly. 

If this risk index increases, investors will likely reduce their holdings of risky assets and move to safe or risk-off assets. The authors show there are real and financial effects from shocks in the GPR index that are consistent with a flight to safety. By construction this index is not forward-looking and is reported with a lag, but there is still likely to be a lagged response by investors. A high GPR value increases the investment wall of worry. This alternative dataset provides some precision on any conversion concerning geopolitical risk.

A close look at 2019 suggests a link between the higher GPR index during the period of lower yields and lower equity values over the summer. The bond rally momentum has slowed with the decline in the GPR index. The country specific indices shows there has been a decrease in risk dispersion. 

Is the world safer or less risky? That question cannot be answered, but a normalized measure of geopolitical news narratives can tell us something about whether these risks are a focus for investors.