Geopolitical uncertainty and sovereign bond yields of BRICS economies

Abstract

Purpose The politically unstable economies have high and volatile sovereign spread. The purpose of this paper is to investigate the impact of geopolitical uncertainty on sovereign bond yields. Design/methodology/approach The sovereign yields at various maturities were decomposed into three factors, namely, level, slope and curvature, using the Dynamic Nelson Siegel model. The relationship between geopolitical uncertainty and the yield curve factors was examined using a quantile causality test. Findings The study found that at the extreme high-rate regime, geopolitical uncertainty causes the yield curve factors positively, indicating bond investors demand a higher return for geopolitical uncertainty. On the other hand, during extreme low-rate regime geopolitical causes the short- and medium-term factors negatively. The extreme low-rate regime indicates the period of economic slowdown. During this regime, the central banks try to reduce the short-term rates to stimulate growth. Originality/value This is one of the few papers that investigates the relationship between the geopolitical risk and sovereign bond yields at the various maturities and interest rate regimes. Understanding the relationship between the geopolitical risk and short-term rates would help the central banks the efficacy of their policy actions. The long-term rates are influenced by the global investor preferences; examining the relationship with the long-term rates would help the investors frame the trading strategies.

Geopolitical Risks and Yield Dynamics in the Australian Sovereign Bond Market

“…To account for the asymmetries identified by Sohag et al (2022) and Subramaniam (2022) regarding the dynamic between geopolitical risk and sovereign yields, this study employs a quantile regression analysis. This is a commonly used model in literature to capture asymmetric relationships by analysing variables at different quantiles (Subramaniam 2022).…”

“…To account for the asymmetries identified by Sohag et al (2022) and Subramaniam (2022) regarding the dynamic between geopolitical risk and sovereign yields, this study employs a quantile regression analysis. This is a commonly used model in literature to capture asymmetric relationships by analysing variables at different quantiles (Subramaniam 2022). This will allow one to account for different interest rate regimes and spread levels, thus capturing the dynamics between yields and geopolitical tensions under various market conditions.…”

“…Spikes in geopolitical risk events have captured the attention of policy makers and academic researchers over the last decade. It is increasingly apparent that market participants consider geopolitical tensions as a risk factor, and that, therefore, such risks are discounted into in the pricing of financial assets (Subramaniam 2022. Geopolitical risk is not a new phenomenon, but the growing importance of geopolitical risks as a driving factor of financial asset prices over recent decades is largely a function of increasingly globally integrated economies and financial markets (Gupta et al 2019;De Wet 2021).…”

“…In part, this is reflected by a typical increase in sovereign quality spreads during periods of elevated geopolitical risk (Baldacci et al 2011). Furthermore, research shows that geopolitical tensions have a significant impact on term spreads, also known as curve spreads, thus influencing yield curve dynamics (Subramaniam 2022).…”

“…Research by Subramaniam (2022) additionally reveals that the impact of geopolitical risk on bond yields depends on the prevailing monetary policy regime. Therefore, geopolitical risk has an asymmetric impact on yields, depending on the prevailing rate cycle (De Wet and Botha 2022).…”