Geopolitical Risk and Investment

57 Pages Posted: 7 Jan 2019 Last revised: 23 Jan 2020

See all articles by Xinjie Wang

Xinjie Wang

Southern University of Science and Technology

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics

Weike Xu

Clemson University - Department of Finance

Date Written: October 1, 2019

Abstract

Using a news-based index of geopolitical risk (GPR), we document a strong negative relationship between firm-level corporate investment and GPR. When the GPR index doubles, investment rate in the next quarter declines by 14% of its sample mean. The effect is more pronounced for firms with more irreversible investment or higher market power, confirming the real options theory. However, the effect is less significant for firms with a stronger ability to substitute labor for capital or with a higher labor-to-capital ratio, supporting the convex return theory. Furthermore, the impact of GPR on investment varies across geopolitically-sensitive sectors. It is stronger for firms in the tourism and its related sectors and is weaker for firms in the defense sector. Overall, our results suggest that the real options channel dominates the Oi-Hartman-Abel effect in driving the negative GPR-investment relationship.

Keywords: geopolitical risk, uncertainty, corporate investment, irreversibility, convexity

JEL Classification: G11, G31, E22

Suggested Citation

Wang, Xinjie and Wu, Yangru and Xu, Weike, Geopolitical Risk and Investment (October 1, 2019). Available at SSRN: https://ssrn.com/abstract=3305739 or http://dx.doi.org/10.2139/ssrn.3305739

Xinjie Wang

Southern University of Science and Technology ( email )

1088 Xueyuan Blvd
Xili, Nanshan District
Shenzhen, Guangdong 518055
China

Yangru Wu

Rutgers University, Newark - School of Business - Department of Finance & Economics ( email )

1 Washington Park
Newark, NJ 07102
United States
973-353-1146 (Phone)
973-353-1006 (Fax)

HOME PAGE: http://andromeda.rutgers.edu/~yangruwu

Weike Xu (Contact Author)

Clemson University - Department of Finance ( email )

425 Sirrine Hall
Clemson, SC 29634
United States

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