Abstract:
We use the k-th order nonparametric causality test at monthly frequency over the period of
1985:1 to 2016:06 to analyze whether geopolitical risks can predict movements in stock returns
and volatility of twenty-four global defense firms. The nonparametric approach controls for the
existing misspecification of a linear framework of causality, and hence, the mild evidence of
causality obtained under the standard Granger tests cannot be relied upon. When we apply the
nonparametric test, we find that there is no evidence of predictability of stock returns of these
defense companies emanating from the geopolitical risk measure. However, the geopolitical risk
index does predict realized volatility in 50 percent of the companies. Our results indicate that
while global geopolitical events over a period of time is less likely to predict returns, such global
risks are more inclined in affecting future risk profile of defense firms.
