Geopolitical Risk in Investment Research: Allies, Adversaries, and Algorithms

Abstract

Geopolitical risk is a driver of just about every type of investment portfolio. However, in practice, most geopolitical research published by investment firms is not informed by international relations theory, giving it a less rigorous, editorial flavor. This article is an attempt to address the latter shortcoming by providing a theoretically grounded framework for analyzing geopolitical risk in an investment context. The first half of the article presents a qualitative framework for analyzing geopolitical risk. The framework uses conceptual tools from international relations theory that can be easily adapted to portfolio management. The second half of the article explores the analysis of geopolitical risk from a quantitative standpoint. The focus of this section is the application of game-theoretic, machine learning, and algorithmic techniques to the study of international relations. The last section of the article briefly addresses the topic of portfolio construction and provides a simple framework for incorporating geopolitical views into the portfolio selection process.

TOPICS: Risk management, global markets, portfolio management/multi-asset allocation, big data/machine learning

Key Findings

• ▪ Analyses of geopolitical risk in an investment context are most effective when formulated in a clear and precisely expressed conceptual framework.

• ▪ Considerations of geopolitical risk often act as defeaters, overriding potentially compelling market-related reasons for or against a particular investment.

• ▪ Quantitative approaches to analyzing geopolitical risk are most useful in the analysis and simulation of the structural relationships between global actors.