To What Extent Does Geopolitical Risk Affect Firms' Idiosyncratic Volatility? Evidence from China

Abstract

Using 2,663 Chinese A-share listed companies from 2003 to 2019, we examine the relationship between geopolitical risk (GPR) and firm’s idiosyncratic volatility and attempt to explain the mechanism. The main findings are presented as follows. First, GPR can explain the change of firms’ idiosyncratic volatility. Different industry conditions and ownerships have heterogeneous effects on the firms’ idiosyncratic volatilities. In addition, the interaction terms of ownership concentration, competitive intensity and operating leverage with GPR are statistically significant, and they interact with GPR to affect firms' idiosyncratic volatility. After conducting a series of robustness tests, we innovatively introduce the South China Sea dispute as an external event and use the DID (Difference-in-difference) model to analyze the impact of geopolitical events on corporate risk-taking, our findings remain valid. Our research contributes to a better understanding of geopolitical risk and firms' idiosyncratic volatility.

Keywords: Geopolitical Risk, Idiosyncratic risk, Idiosyncratic volatility, the South China Sea dispute