Journal Pre-proof

What are the categories of geopolitical risks that could drive oil prices
higher? Acts or threats?

Jamal Bouiyour, Refk Selmi, Shawkat Hammoudeh, Mark E. Wohar

PII: S0140-9883(19)30318-4
DOI: https://doi.org/10.1016/j.eneco.2019.104523
Reference: ENEECO 104523

To appear in:

Received Date: 20 May 2019

Revised Date: 15 September 2019
Accepted Date: 17 September 2019

Please cite this article as: Bouiyour J, Selmi R, Hammoudeh S, Wohar ME, What are the
categories of geopolitical risks that could drive oil prices higher? Acts or threats?, Energy
Economics (2019), doi: https://doi.org/10.1016/j.eneco.2019.104523

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 What are the categories of geopolitical risks that could drive oil
prices higher? Acts or threats?

Jamal BOUIYOUR
IRMAPE-ESC Pau Business School, France.
CATT, University of Pau, France.
Email: jamal.bouiyour@univ-pau.fr
Refk SELMI
IRMAPE-ESC Pau Business School, France.
CATT, University of Pau, France.
Email: s.refk@yahoo.fr
Shawkat HAMMOUDEH
Lebow College of Business, Drexel University, Philadelphia, USA.
Email: shawkat.hammoudeh@gmail.com

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Mark E. WOHAR
Corresponding author: College of Business Administration, University of Nebraska
at Omaha, 6708 Pine Street, Omaha, NE 68182, USA; School of Business and

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Economics, Loughborough University, Leicestershire, LE11 3TU, UK.
Email: mwohar@unomaha.edu

Graphical abstract
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Global
geopolitical
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risk

Geopolitical acts: Threats of adverse events:

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1990-1991 Gulf War, 11/9 Nuclear menaces and

terror attacks, 2003 Iraq military force threats.
invasion, 2013 Ukraine-Russia
conflict, imposition of
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sanctions targeting Iran’s and

Venezuela’s oil industries,
imposition of US tariffs on Copula with
Chinese goods, etc.
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regime-
switching

Non-significant or
Positive and
moderate relationship
strong relationship
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 Acts
Oil is multifractal and
Multifractal characterized by a
Oil
persistent long memory
Detrended returns phenomenon in its short-
Fluctuation
Threat term components.
analysis
s

The oil market is

far from being
efficient.

Notes: : A low level of oil prices associated with an episode of falling geopolitical risk; : A high level

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of oil prices associated with an episode of rising geopolitical risk; : A low level of oil prices associated with
an episode of rising geopolitical risk; :A high level of oil prices associated with an episode of falling geopolitical
risk.

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Highlights


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We evaluate the dynamic dependence between oil prices and geopolitical risks.
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 We separate shocks due to geopolitical acts from those due to geopolitical threats.


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We construct a composite geopolitical risk indicator that summarizes recent sources of

risks ignored in the Caldara and Iacoviello (2018)’ index.


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We show a positive and strong (moderate) response of oil prices to geopolitical acts

(threats).
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 The reaction of oil to geopolitical risks is conditional on different categories of

geopolitical risks and oil market states.

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Abstract: This study characterizes the oil market as a nonlinear-switching phenomenon and
examines its dynamics in response to changes in geopolitical risks over low- and high-risk
scenarios. We separate the shocks due to geopolitical acts from those due to geopolitical
threats to address whether the serious effects of geopolitical risks are mostly due to
increased threats of adverse events or to their realization as acts. While we find the acts to
generate a positive and strong impact on oil price dynamics, the effect of threats appears to
be moderate or non-significant. Imperfect information in the oil price determination, the

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history of oil supply disruptions emanating from geopolitical events, the continued rise in
populism in the world, oil market volatility, multifractility and the time-varying degree of weak-
form efficiency have been advanced to explain the unforeseen responses of oil prices to
geopolitical threats. To accommodate recent oil-related events, we construct a composite
geopolitical risk indicator by accounting for contemporaneous sources of geopolitical risks,
namely global trade tensions, US-China relation risks, US-Iran tensions, Saudi Arabia’s
uncertainty and Venezuela’s crisis. The combined effects have an outsized impact on oil
prices.

Keywords: Oil market, geopolitical risks, dynamic copula with Markov-switching regimes,
new dependence-switching copula, multifractal detrended fluctuation analysis.

JEL classification: G11, G15, C58.

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1. Introduction

Geopolitical risks (GPRs) have garnered a great deal of attention in academia. More
recently, the role of geopolitical uncertainties has also been stressed as an important driver
of the state of the economy, and as a result there has been an increase in research on the
relationship between the nature of conflicts and economics (Skaperdas, 2008). GPRs refer
to a measure of political tensions in the economy as they serve as an important factor in
pricing asset markets (Bailey and Chung, 1995; Asteriou and Siriopoulos, 2003; Fielding,
2003; Santa-Clara and Valkanov, 2003; Snowberg et al., 2007). Violence goes beyond the
destruction of human and physical capital since it spills over to the economic and social life.
Additionally, the study of the effect of GPRs on the economy has received much attention
because of the increasing events of political conflicts, civil wars, international wars, and

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terrorist attacks in the current century (Blattman and Miguel, 2010). Characteristics of events
related to domestic and international political environment affect economic and corporate

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investing behaviors considerably (Wolfers and Zitzewitz, 2009; Bialkowski et al., 2008;
Gaibulloev and Sandler, 2008). Central banks, business investigators and the financial press
have listed GPRs as a key determinant of investment decisions (Caldara and Iacoviello,
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2018).
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Observations on the influence that GPRs exert on an economy have also influenced
the empirical studies on the nature of conflicts and their relation to economics. They have
also attracted a considerable number of studies attempting to examine the effects of different
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types of geopolitical activities on asset markets. Research on this topic is important because
the recurrent episodes of civil war, international wars, political unrest, and terrorist attacks
have been experienced by many nations in the current century, and in fact civil wars alone
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have afflicted one third of all nations (Blattman and Miguel, 2010). Examples of such events
are elections of new important officials, changes in governments and occurrences of political
upheavals, civil strifes or more violent episodes such as terrorist attacks that affect economic
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performance and asset markets (Guidolin and La Ferrara, 2010; Drakos and Kallandranis,
2015; Gaibulloev and Sandler, 2009). The 2001 World Trade Centre tragedy in New York is
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the largest insured loss event in history. In addition, some recent examples of events that stir
up GRPs include the Paris attack in November 2015, the decision of the United Kingdom in
June 2016 to leave the European Union (Brexit), the U.S. election of Donald Trump in
November 2016, the tension between North Korea and the United States throughout 2017
and half of 2018, prompting heightened geopolitical instability, etc.

This kind of political news creates geopolitical impacts, which renews the belief that
political risk is a key factor in influencing different asset markets. It is therefore important to

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examine whether an asset is resistant or not to geopolitical shocks. In the Gallup 2017
survey, which represents the views of more than 1,000 investors. About 75 percent of the
respondents conveyed worries about the possible economic effects of multiple military and
diplomatic conflicts occuring around the world, thereby ranking geopolitical risk ahead of
political and economic policy uncertainties. Accordingly, Carney (2016) and Caldara and
lacoviello (2018) indicated that GPRs, together with financial, macroeconomic and economic
policy uncertainties, could have harmful economic consequences and significant negative
effects on asset price dynamics.

Although the empirical literature on the dependence between different uncertainty

indicators and asset prices is noticeably increasing (see for example, Aloui et al., 2016;
Balcilar et al., 2016; Bouoiyour et al., 2018; Beckmann et al., 2019, among others), the

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effects of geopolitical risks on financial and macroeconomic variables have not been the
subject of many serious empirical investigations. The dominant limitation has been the lack

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of a relevant indicator of geopolitical risk that measures this risk in real time and is consistent
over time. The majority of studies have examined the role of geopolitical events in
determining the movements of financial market returns and volatility (e.g., Chen and Siems,
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2004; Eldor and Melnick, 2004; Johnston and Nedelescu, 2006; Abadie and Gardeazabal,
2008; Arin et al., 2008; Fernandez, 2008; Nikkinen et al., 2008; Nguyen and Enomoto, 2009;
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Drakos, 2010; Gul et al., 2010; Karolyi and Martell, 2010; Kollias et al., 2010, 2013; Chesney
et al., 2011; Suleman, 2012; Christofis et al., 2013; Aslam and Kang, 2015; Balcilar et al.,
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2016, Gupta et al., 2017).

All these works conclude that geopolitical risks significantly affect stock returns and
volatility. Nevertheless, as far as the impact of geopolitical uncertainty on oil price dynamics
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is concerned, and to the best of our knowledge, there has been only very few studies that
emphasize the importance of geopolitics in analyzing oil price dynamics (Noguera-Santaella,
2016 ; Antonakakis et al., 2017; Datta et al., 2017; Omar et al., 2017; Ramiah et al., 2018).
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Noguera-Santaella (2016) investigates the link between armed and civil conflicts and oil
prices by assessing the effect of 32 different geopolitical events ranging from the American
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Civil War to the recent Arab Spring on oil price movements. It was shown that geopolitical
events exert a positive influence on oil prices before year 2000 but have a moderate effect
afterwards. Antonakakis et al. (2017) examine the effects of global tension, friction and
conflict on the oil and stock market dynamics and then on their association. They find that the
oil market seems to be more affected by geopolitical tensions in terms of return and volatility,
while the stock market appears much less affected. Datta et al. (2017) employed the
probability density functions around periods of heightened geopolitical tensions and oil
supply disruption in an attempt to examine (a) the extent to which oil price changes are

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expected or unexpected, and (b) whether these movements tend to be persistent or
transitory. Omar et al. (2017) assessed the behavior of the oil market around the outbreaks
of severe international crises and wars. By conducting an event study methodology, they
have found that these events are significantly associated with positive oil abnormal returns,
thus highlighting that oil could be a good safe haven in times of rising geopolitical tensions.
Ramiah et al. (2018) performed an improved event study methodology to explore the impact
of the recent terrorist attacks (in particular those that occurred in Paris, Nice, Brussels,
Stockholm, Manchester, Jakarta, London and Melbourne) on returns in commodity markets,
compared to stock markets. They have found that terror attacks exacerbate uncertainty in
both commodity and equity markets. However, a delayed response of investors in commodity
markets is found, in comparison to equity markets.

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Despite the relevance of the results found in these studies and their originality, the
use of geopolitical proxies does not properly define geopolitical risk as they do not account

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for all events, ranging from wars to major economic crises to climate change.

To avoid the multiple shortcomings of the existing geopolitical indicators, Caldara and
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Iacoviello (2018) proposed a broad measure of global geopolitical uncertainty that detects
both the risk that these events would materialize, and the new risks linked to an upward
surge of the existing events or acts. More specifically, it differentiates between the direct
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effect of geopolitical events by accounting for mentions of military-related tensions involving
large regions of the world and the U.S. involvements and the nuclear tensions, and the effect
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of pure GPRs considering the geopolitical events which can be expected to prompt a
heightened geopolitical uncertainty including terrorist acts and the beginning of a war. The
analysis of our study is complementary to a large strand of the literature that examines the
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economic effects of wars, terror attacks, and other forms of collective violence including
Tavares (2004), Glick and Taylor (2010), and more recently, Moretti et al. (2014) and Aghion
et al. (2017).
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The assessment of the impact of different geopolitical categories (in particular, acts
and threats) may have important implications for two main reasons. First, adverse
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geopolitical acts may trigger a rise in geopolitical threats. For example, a terrorist attack may
lead to an increase in the threat risk of future attacks. This underscores that searching for
realized events (i.e., acts) rather than the global geopolitical risk can allow obtaining an
accurate identification of some risk-inducing shocks. Second, differentiating between
geopolitical threats and acts tends to serve as an effective learning mechanism for investors
and risk managers. Such a precise analysis would allow them to appropriately assess the
risk component in their portfolios. As investors expect an encroachment of future geopolitical
risks, they would try to mitigate the harmful impact on their portfolios by investing in assets

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which are stable and strong, to provide them with a sense of safety by directing the
sentiments away from the drastic impact of fear and insecurity associated with such
geopolitical events (Ciner et al., 2013).
Most of the available studies that examine the role of uncertainty in driving oil price
movements have been conducted using a linear framework or a tail dependence while
ignoring the possible occurrence of different regime shifts (for example, Aloui et al., 2016;
Antonakakis et al., 2017). Our study attempts to fill this gap by applying a new copula-based
approach that is able to shed a new light on the dynamic dependence between oil prices and
geopolitical risks under low- and high risk conditions and accounts for nuances of oil price
movements (i.e., low or high). Specifically, we employ alternative modelling approaches
based on some recent studies that use copula classes (for instance, Aloui et al., 2016) and

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Markov-switching models to assess the relationship between oil and other asset prices (for
example, Balcilar et al., 2015). The appeal of the copula models is that they ease the
separate modeling of the marginal distributions and the dependence, and therefore, a variety

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of dependence structures can be detected with more flexibility and parsimony.
Another relatively new copula model that is used throughout this research is the
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dependence-switching copula approach which is recently developed by Wang et al. (2013).
This newly econometric tool mixes the Clayton copula with the Survival Clayton copula to
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allow for asymmetric instead of symmetric tail dependence. It is flexible to enable switching
between various correlation regimes, while considering different scenarios. This would help
to adequately model the nonlinear and asymmetric relationship between time series, which
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complements the common copulas (i.e., the Normal, t, Clayton, rotated Clayton, Gumbel and
rotated Gumbel copulas).
Furthermore, assuming that the efficient market hypothesis requires a significant
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transparency and instantaneous reactivity with respect to new information, and considering
that the informational efficiency may change with major geopolitical events such as terrorist
attacks, wars and other important events, another purpose of this study is to examine the
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effects of geopolitical risks on the evolution of the informational efficiency of the oil
market. The efficient market hypothesis (EMH) has been largely tested in the literature for
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many financial assets (Fama, 1970; Cornell and Dietrich, 1978; Kwapień et al., 2005; Wang
et al., 2009) and several commodities (Roll, 1972; Koutsoyiannis, 1983; Wang et al., 2011).
Moreover, some works including Tabak and Cajueiro (2007), Alvarez-Ramirez et al. (2008),
Maslyuk and Smyth (2008) and Charles and Darné (2009) tested the efficiency of crude oil
markets from the view of time-varying, long-range dependence and the Hurst exponent
dynamics based on the detrended fluctuation analysis (DFA). They show that these markets
seem to be weak-form efficient. However, throughout the present research, we extend the
assessment of the weak-form of the EMH to the crude oil markets by comparing: (i) the

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impact of geopolitical threats and acts on the efficiency of crude oil market; and (ii) the
relative efficiency between the short- and long-run horizons and the small and large
fluctuations of oil price dynamics, by using the multifractal detrended fluctuation analysis
(MF-DFA) approach. The latter is a generalization of a monofractal analysis in which a single
exponent or the fractal dimension is not sufficient to successfully depict the dynamics of a
complex system. A multifractal assessment enables one to accurately depict the fluctuations
along the time of the regularity of the sample path of a function. This is fulfilled by comparing
the local variations around the time position against a local power law behavior. In short, the
MF-DFA is a flexible tool that controls for possible long-dependence, nonlinearity, fat-tails,
and volatility clustering in the oil price dynamics. From a risk management perspective,
conducting such fine analyses, accounting for asymmetry and nonlinearity (i.e., a state-by-

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state correlation) and multifractility is very beneficial for market participants (in particular,
traders, investors and risk managers) as this would allow them to effectively protect against
unforeseen shocks and rising uncertainties.

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In doing so, we show robust evidence of a positive and strong (non-significant or
modest) response of oil prices to realized geopolitical acts (threats). We also find that all
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kinds of oil fluctuations are persistent in the short-term which could be interpreted by the
speculative behavior in the global oil market. Overall, we conclude that investing in crude oil
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may be a good strategy for market participants who seek a protection against high
geopolitical uncertainty. But this ability is conditional on the various kinds of geopolitical risks
and oil price movements (low or high), oil features (lack of efficiency, multifractality, volatility
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and speculation), and the categories of geopolitical risks (i.e., threats or realized acts).

The remainder of the study is organized as follows: Section 2 introduces the data and
describes the methodology. Section 3 reports and discusses the empirical estimation results
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drawn using a range of geopolitical risk indicators and flexible econometric models. In the
same section, we apply various sensitivity tests to check the robustness of our results.
Section 4 concludes.
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2. Data and methodology

2.1. Data and descriptive statistics

We use the newly constructed monthly geopolitical risk index (GPRI), developed by
Caldara and Iacoviello (2018) to represent the geopolitical risks. This indicator is developed
based on searching for the number of articles related to the six categories of geopolitical
events and tensions in 11 leading newspapers for each month.

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 More importantly, Caldara and Iacoviello (2018) distinguish between the direct
harmful impact of geopolitical events and the impact of pure geopolitical risks. They do this
by proposing two potential risk indicators, namely the geopolitical threats index (GPTI), which
focus on words belonging to military-related tensions or nuclear tensions, and the geopolitical
acts index (GPAI) which pay particular attention to words related to terrorist attacks or the
beginning of war. To be consistent in our analysis, we consider similar frequencies and time
periods for all the variables under study. Thus, we consider the monthly oil price data of the
European Brent crude. The data for the Brent crude oil price has been sourced from the US
Energy Information Administration.1
The data of the different geopolitical risk measures is constructed by Caldara and
Lacoviello (2018) by counting the occurrence of words related to geopolitical tensions in

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leading international newspapers.2 The downloaded data of the Brent oil price, geopolitical
risk index, the geopolitical threats index and the geopolitical acts index covers the period
January 1985-April 2018. The data for changes in Oil, GPRI, GPTI and GPA are plotted in

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Figure 1. We utilize the logarithm of monthly return series, that is, rt=log (It /It–1) where It is
the index level for any series at time t and It-1 is the index level of the time series at time t-1.
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We observe that the period under study experienced a heightened uncertainty, particularly
surrounding unforeseen geopolitical threats and acts.
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For the same period, we note that the oil price exhibits a volatile behavior.
Interestingly, the graphical evidence indicates that there are some periods where oil and the
three geopolitical risk indicators appear to be positively correlated. For instance, we note
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specific periods (in particular, around the 1990-1991 Gulf War, after the 9/11 attack, during
the 2003 Iraq invasion, during the Arab Spring, and during the 2014 Russia-Ukraine crisis)
where an increase in the geopolitical risk is accompanied by an increase in the oil price. This
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holds true for all of the risk indicators, though with different magnitudes. Such heterogeneity
in the strength of the reactions of the oil price and geopolitical risk indexes sets out the
relevance of using different indicators to account for the core effects of the geopolitical risks.
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Furthermore, there are some periods where the oil price and the various geopolitical risk
indexes operate in opposite directions. This underscores the paramount importance of
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analyzing this relationship under diverse correlation regimes, which prompts the usefulness
of the dependence-switching copula model.
INSERT Figure 1 about here

1
Please refer to this link: https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RBRTE&f=M
2
Data is available via : https://www2.bc.edu/matteo-iacoviello/gpr.htm#data

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 The descriptive statistics are summarized in Table 1 and show that the mean returns
are close to zero for all of the return series and appear to be small relative to their standard
deviations, implying that there is no significant trend in the data. The standard deviation
values indicate that the oil price and the GPRI returns are more volatile than the GPTI and
GPAI return series. The coefficients of skewness and kurtosis reveal that all the returns are
skewed and exhibit a significant leptokurtosisness. The Jarque-Bera test statistic of the GPAI
is 24.822, which is higher than the corresponding values of GPRI and GPTI (11.439 and
15.855, respectively). The null hypothesis of the normal distribution has been rejected for
these three geopolitical risk indices as well as the oil return series at the 1% significance
level, thus justifying an analysis of extreme dependence.

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INSERT Table 1 about here

We have also tested the occurrence of nonlinearities in the considered time series by

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using the BDS test (Brock et al., 1996)3 of nonlinearity on the residuals recovered from the
VAR models (see notes to Table 2). The estimated findings are summarized in Table 2 which
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show strong evidence of nonlinearity, as they reject the null hypothesis of independent and
identical distribution (i.i.d). More precisely, the results suggest that Oil, GPRI, GPTI and GPA
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are non-linearly dependent, which is one of the indications of a chaotic behavior, and thus
justifies the appropriateness of copula with regime-switching for assessing the nonlinear
relationship between geopolitical risks and oil returns.
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INSERT Table 2 about here

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2.2. Methodology
The use of econometric approaches that acknowledge shifts in the dependence
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structure between oil prices and geopolitical risks can be very useful and beneficial towards
the design of more appropriate regulatory frameworks and can also limit systemic risks
during stressed market scenarios. Currently, the rising complexity of the data employed in
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research and business analytics requires flexible, robust, and scalable econometric tools.
Accordingly, the present research performs relatively new techniques that meet these
requirements.

3 The BDS test is the most popular test for nonlinearity. It was originally designed to test for the null
hypothesis of the independent and identical distribution for the purpose of capturing non-random chaotic
dynamics. When carried out on the residuals from a fitted linear time series model, the BDS test can be
employed to control for a possibly omitted nonlinear structure. If the null hypothesis is rejected, this this
implies that the fitted linear model is misspecified.

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2.2.1. Dynamic copula with Markov-switching model
we first utilize a flexible Markov-switching dynamic (autoregressive) copula approach,
namely the dynamic copula with Markov-switching as developed by Fei et al. (2013), which
detects asymmetry in the form of a high or a crisis dependence and a low or a normal state
dependence. Markov switching allows us to examine the possibility that the dynamic
behaviours of oil returns and the changes in geopolitical risk depend on the regime that
occurs at any given point in time. This characteristic distinguishes this technique from
conventional copulas and standard regime-switching models where a function is presumed to
govern each regime, despite how long the given state prevails. Several empirical studies
have linked the low dependence regime with the Gaussian copula which presumes zero tail

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dependence to the high dependence regime with the non-Gaussian copula that allows for tail
dependence. For example, the standard Markov-switching copula initiated by Rodriguez
(2007) assumes that the means, variances and correlations shift simultaneously and that

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each regime is dictated by a different static copula.

Likewise, Chollete et al. (2009) and Garcia and Tsafack (2011) proposed dependence
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models which are parameterized by a static Gaussian copula in normal conditions and a
mixture of static elliptical/Archimedean copulas in a bearish regime (or the regime with the
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high volatility). Following Fei et al. (2013) and while trying to outline the dynamic copula with
Markov-switching framework, let St be a state variable that represents the prevailing regime.
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The joint distribution of X1t and X2t conditional on being in regime s is expressed as follows:

( X 1t , X 2t X 1,t 1 , X 2,t 1 ; S t  s)  C tSt (1t ,  2t 1,t 1 ,  2,t 1 ; 

St
t
) (1)
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where s ∈ {H, L} and H is the high dependence regime and L is the low dependence regime.
The random variable St follows a Markov chain of order one distinguished by the transition
probability matrix denoted as:
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  HH 1   HH 
  1     (2)
 LL LL 
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 

where πHH and πLL are the so-called staying probabilities, namely, πHH (πLL) is the probability of
being in the high (low) dependence regime at time t conditional on being in the same regime
at time t − 1.

Previously, Patton (2006) sets out the foundations for time-varying copulas by
demonstrating Sklar's theorem for conditional distributions, and claims the generic copula

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dependence parameter θ evolves in an ARMA fashion, which permits a mean-reversion in
dependence based on the forcing variable t , as follows:

 t  (   t 1 t ) (3)

The dynamic copula with Markov-switching which was recently developed attempts
first to apply a regime-switching ARMA copula where the dependence structure evolves as
follows:

 tS  ( S   tS1 t )

t t t 1
(4)

where Λ (·) is the modified logistic or exponential function.4 Second, a regime-

switching dependence model is carried out where the time-varying copula function that

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governs each regime is of the Dynamic Conditional Correlation (DCC, hereafter) class5
expressed as follows:

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QtSt  (1   St  St Q )  St QtSt11  St  t 1 (5)

S
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where Qt t is the auxiliary matrix that determines the rank correlation dynamics,

 S  S  1;  S , S  (0,1) . Throughout the present empirical investigation, the Gumbel

t t t t
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copula is used for all regimes, but it allows for time-variation (mean reversion) in the
dependence and the tail dependence within each regime. This would permit one to capture
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sharp increases (decreases) in dependence in times of crisis (tranquility) states without

imposing the restriction of the static within-regime dependence.
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2.2.2. A Copula with a Regime Switching

Instead of focusing on the changes in tail dependence of a single copula, this paper goes
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beyond that by emphasizing on the switch among positive and negative correlation regimes
conditional on an unobserved state variable. This study explores the dynamic dependence
between oil returns (X1) and the different measures of geopolitical risk (X2). According to
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4 In the context of elliptical copulas, the dynamic parameter is the conventional correlation measure, θt
= ρt, and Λ (y) = (1 − e−y) (1 + e−y )−1 is the modified logistic transformation to ascertain that ρt ∈ (−1, 1).
Once these parameters are estimated, they can be mapped into a time-varying rank-correlation and tail
dependence measures. In the Symmetrized Joe-Clayton (SJC) copula, the parameters modeled in Eq.
(2) are directly the upper tail dependence, θt = λ U t (or the lower tail dependence θt = λ L t ), and Λ (y) =
(1 + e−y )−1 is the logistic transformation to ensure that λ U t , λL t ∈ (0, 1).
5 The Dynamic Conditional Correlation (DCC) model enables correlations to vary over time. It takes into

account different features of an asset including long memory behavior, nonlinearity, asymmetry and/or
leverage effects.

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Sklar’s (1959) theorem, a bivariate joint cumulative distribution function (F) of oil returns (x1,t )
and geopolitical indicators (x2,𝑡 ) can be decomposed into the two marginal cumulative
distribution functions (Fx1 and Fx2 ) and a copula cumulative distribution function (C) that
depicts the dependence structure among the two variables:

F(x1,t , x2,𝑡 ; ∂1 , ∂2 , 𝜃 𝑐 ) = C(F𝑥1 (x1,t ; ∂1 ), F𝑥2 (x2,t ; ∂2 ); 𝜃 𝑐 ) (6)

where 𝐹𝑘 (𝑥𝑘,𝑡 ; 𝜕𝑘 ) , 𝑘 = 1 , 2, is the marginal cumulative distribution function of x𝑘,t , and ∂𝑘

and 𝜃 𝑐 are the parameter sets of F𝑘 (x𝑘,t ; ∂𝑘 ) and C, respectively. Assuming that all
cumulative distribution functions are differentiable, the bivariate joint density is thereafter
denoted as:

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𝑓(x1,t , x2,𝑡 ; ∂1 , ∂2 , 𝜃 𝑐 ) = C(u1,𝑡 , u2,𝑡 ; 𝜃 𝑐 ) ∙ ∏2𝑘=1 𝑓𝑘 ( x𝑘,t ; ∂𝑘 ) (7)
where 𝑓(x1,t , x2,𝑡 ; ∂1 , ∂2 , 𝜃 𝑐 ) = 𝜕𝐹 2 (x1,t , x2,𝑡 ; ∂1 , ∂2 , 𝜃 𝑐 )/𝜕x1,t 𝜕x2,𝑡 is the joint density of x1,𝑡

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and x2,𝑡 ; u𝑘,𝑡 is the “probability integral transforms” of x𝑘,𝑡 based on F𝑘 (x𝑘,t ; ∂𝑘 ), 𝑘 =
1,2; 𝑐(𝑢1,𝑡 , 𝑢2,𝑡 ; 𝜃 𝑐 ) = 𝜕𝐶 2 (𝑢1,𝑡 , −𝑢2,𝑡 ; 𝜃 𝑐 ) = 𝜕𝐶 2 (𝑢1,𝑡 , 𝑢2,𝑡 ; 𝜃 𝑐 )/ 𝜕u1,t 𝜕u2,𝑡 is the copula density
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function; and 𝑓𝑘 (x𝑘,t ; ∂𝑘 ) is the marginal density of x𝑘,t , 𝑘 = 1,2. Thus, the bivariate joint
density of x1,t and x2,t is the product of the copula density and two marginal densities.
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To detect the dependence switching, we consider the following regime-switching
copula in which the unobserved state variable, St, exerts a significant impact on the copula
function and marginal models.
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𝐶1 (u1,𝑡 , u2,𝑡 ; 𝜃1𝑐 ), 𝑖𝑓 S𝑡 = 1

𝐶𝑆𝑡 (u1,𝑡 , u2,𝑡 ; 𝜃1𝑐 , 𝜃0𝑐 ) = { (8)
𝐶0 (u1,𝑡 , u2,𝑡 ; 𝜃0𝑐 ), 𝑖𝑓 S𝑡 = 2
where 𝐶1 (u1,𝑡 , u2,𝑡 ; 𝜃1𝑐 ) and 𝐶0 (u1,𝑡 , u2,𝑡 ; 𝜃0𝑐 ) are two mixed copulas with positive and negative
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dependence structures, respectively. The above copula functions mix the Clayton copula (C 𝐶 )
with the Survival Clayton copula (C𝑆𝐶 ) to allow for asymmetric instead of symmetric tail
dependence under different market statuses (Wang et al., 2013).
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𝐶1 (u1,𝑡 , u2,𝑡 ; 𝜃1𝑐 ) = 0.5C 𝐶 (u1,𝑡 , u2,𝑡 ; 𝛼1 ) + 0.5C𝑆𝐶 (u1,𝑡 , u2,𝑡 ; 𝛼2 ) (9)
𝐶0 (u1,𝑡 , u2,𝑡 ; 𝜃0𝑐 ) = 0.5C 𝐶 (1 − u1,𝑡 , u2,𝑡 ; 𝛼3 ) + 0.5C𝑆𝐶 (1 − u1,𝑡 , u2,𝑡 ; 𝛼4 ) (10)
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1
where 𝜃1𝑐 = (𝛼1 , 𝛼2 )′ , 𝜃0𝑐 = (𝛼3 , 𝛼4 )′ , C 𝐶 (𝑢, v; 𝛼) = (𝑢−𝛼 + 𝑣 −𝛼 − 1)−𝛼 , C𝑆𝐶 (𝑢, v; 𝛼) = 𝑢 + 𝑣 − 1 +
C 𝐶 (1 − 𝑢, 1 − v; 𝛼), and 𝛼 ∈ (0, ∞).
After estimating the shape parameter, 𝛼𝑖 , we transform it in order to obtain Kendall’s 𝜏𝑖 , the
𝛼 𝜏
correlation coefficient (𝜌𝑖 ) and the tail dependence (𝜑𝑖 ), with 𝜏𝑖 = 2+𝛼𝑖 , 𝜌𝑖 = sin (𝜋 ∗ 2𝑖) and
𝑖
1
−
𝜑𝑖 = 0.5 ∗ 2 𝛼𝑖
for 𝑖 = 1,2,3,4.

13
 In short, this paper focuses on switching among positive and negative correlation
regimes, conditional on an unobserved state variable. A negative correlation regime consists
of a period where a high (low) oil price coexists with a falling (rising) geopolitical risk
𝜑𝑖 1 (𝜑𝑖 2). On the other hand, a positive correlation regime implies that a high oil price is

associated with a rising geopolitical risk (𝜑𝑖 4), and a low oil price coexists with a decreasing

geopolitical risk (𝜑𝑖 3). St follows a two-state Markov chain with a transition probability matrix:

𝑃00 1 − 𝑃00
𝑃=[ ] (11)
1 − 𝑃11 𝑃11
where 𝑃𝑖𝑗 = 𝑃𝑟 [𝑆𝑡 = 𝑗|𝑆𝑡−1 = 𝑖] for 𝑖, 𝑗 = 0,1. The state variable (𝑆𝑡 ) switches between a
positive dependence regime (𝑆𝑡 = 1) and a negative dependence regime (𝑆𝑡 = 0).

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2.2.3. A Multifractal Detrended Fluctuation Analysis

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We investigate, thereafter, the impact of different geopolitical events on the time-
varying informational efficiency of the oil market. For this purpose, a multifractal detrended
fluctuation analysis (MF-DFA) is conducted.
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Following Kantelhardt et al. (2002), the MF-DFA procedure mainly consists of five
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steps. The MF-DFA method is generally conducted when a time series exhibits a fractal
structure over time. In other words, this technique allows us to evaluate the multifractal
properties of the oil market by exploring the scaling behavior of the fluctuation functions.
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Let us assume that xk : K  1,2,..., N is a time series of length N .

The first step consists of determining the profile i .

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i  k 1 ( x k  x ), i  1,2,..., N
i
(12)
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where x  1  N
 N
k 1
xk .
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Step two consists of dividing i into N s  N  s  non-overlapping segments of equal le

ngths where s is the scale. It must be stressed here that the s value is chosen depending on
the length of the series. While attempting not to disregard any parts of the series, always alto

gether 2N s segments of equal length are derived.

Throughout step three, we determine the local trend for each of the 2Ns segments. Thi

14
s is achieved by means of a least-square fit of the segments or subseries. In this background
, high order polynomials are utilized to detrend the series, and consequently the procedure is

likely to be the MF-DFA1, MF-DFA2, MF-DFA3, . . . The order of the polynomial y (i) determ
ines the order of the trend in the time series which will be removed.

Let y be the best fitted polynomial to an arbitrary segment  of the series under study.

Thereafter, we calculate the variance as follows:

F 2 ( s,  ) 
1 s
i 1
(  1)s  i  y (i) for
2
  1,2,..., N s (13)
s

and

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F 2 ( s,  ) 
1 s
  N  (  N ) s  i   y  (i )
2
for   N s  1,...,2 N s (14)
s i 1
s

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Step four consists of averaging over all segments to obtain the qth order MF-DFA fluctuation f
unction:

1
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 1 
 
q
2 
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q
v1 
2Ns
Fq ( s)   F 2
( s , )  (15)
 2 N 
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Thereafter, the scaling behavior of the fluctuation functions is assessed for distinct values of t
he exponent q.
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Step five consists of determining the scaling behavior of the fluctuation functions by ex
amining the log–log plots of Fq(s) versus s for each value of q. If the series

xk : K  1,2,..., N possesses long range power-law correlated, Fq(s) rises for wider values
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of s, as a power-law:
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(16)

The scaling exponents h(q) are drawn via the slope of the log-log plot of Fq(s) versus s
. These scaling exponents h(q) are the generalization of the Hurst exponent H (≡ h(2)). A H=
0.5 implies that the series follows an uncorrelated Brownian process, and therefore the mark
et is efficient. According to the efficient market hypothesis, the oil market is efficient if all of its
fluctuations follow a random walk behavior. This translates into h(q)’s associated with various
q’s are equal to 0.5. For the present assessment, we focus on large and small fluctuations, a

15
nd hence h(q) defines an oil market’s inefficiency measure based on the multifractal
dimension (IDM).

IDM 
1
 h(5)  0.5   h(5)  0.5  (17)
2

According to Equation (17), large fluctuations (q=+5) and small fluctuations (q=-5) follow a ra
ndom walk process, and therefore an IDM value closer to 0 will translate into a high degree o
f efficiency. This means that the oil market is efficient if the value of IDM is close to zero, whil
e strong IDM values indicate a less efficient market.
Then, to test the effect of geopolitical acts on the varying efficiency of the oil market,
we compare the degree of efficiency for the periods prior and post the 1990-1991Gulf War,

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the 9/11 terrorist attacks, the 2003 invasion of Iraq and the 2013 Ukraine-Russia crisis.
Concerning the geopolitical threats, we test whether the efficiency of the oil market changes
after July 2015 (i.e., the Iran nuclear agreement threatening to develop its nuclear arsenal).

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We also consider the period after February 2014 during which North Korean officials have
threatened a nuclear attack on the U.S. for years, in retaliation for similar threats from the
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U.S. Further, we assess whether the oil market efficiency increases with the heightened
tensions between North Korea and the United States after the ‘America First’ security speech
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(December 2017), in which Trump puts North Korea high on the security agenda.

3. Empirical findings
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In general, the ability of an asset to act as a hedge and a safe haven in uncertain
times depends on how this asset and uncertainty are related. Some studies (for instance,
Jones and Sackley, 2016) do not differentiate between a hedge and a safe haven. More
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precisely, they do not consider the co-movements between the prices of an asset and
uncertainty under various scenarios. We aim, in the following, to fill this gap by directly
analyzing the responses of oil prices to geopolitical risks based on a Markov-switching model
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and a dependence-switching copula synchronizing different episodes of geopolitical risks

(i.e., low- and high-risks). According to Bouoiyour et al. (2018), an asset can be seen as a
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safe haven if it is positively correlated with uncertainty when the risk is high. Throughout this
study, we test whether oil acts serve as a safe haven during times of increased geopolitical
risks (both acts and threats).

3.1. A Dynamic Copula with Regime-Switching Results

16
 The parameters H and L of a dynamic copula with Markov-switching model (see
Table 3) reveal that the level of dependence is positive and strong for the oil price with

geopolitical acts in a crisis period (  H ), whereas the parameter L appears very modest in
low volatility or normal states. However, both the crisis and normal conditions exhibit a non-
significant linkage between the oil price and threats of geopolitical adverse events. The
significance of parameters  and  indicates that rank correlations are time-varying. The
persistence measure (  and  ) suggests that the rank correlation of the oil price and
geopolitical acts is more persistent than that of the oil price and geopolitical threats. The
probabilities πHH and πLL consistently indicate a longer duration of the high (low) dependence
regime for the oil price and geopolitical acts (threats). The result indicating that the

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correlation between geopolitical acts and the oil price is positive and stronger during times of
increased uncertainty is not surprising and is in line with the existing literature (see, for

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instance, Noguera-Santaella, 2016; Antonakakis et al., 2017). Nonetheless, the non-
significant impact of geopolitical threats on the oil dynamics is contrary to intuition or to the
common-sense expectations. This can be explained by the multifractality and the underlying
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formation mechanisms in international crude oil markets (see below). In addition, different
countries have gained experiences from previous incidents or acts and have pursued proper
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policies that are very specific with respect to the occurred events, which can explain the
capability to absorb the adverse impacts of threats on oil prices.
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INSERT Table 3 about here

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3.2. Dependence-switching copula model results

Table 4 reports the findings of the dependence-switching copula for the relationship
between the oil returns and the three geopolitical risk indicators (i.e., global geopolitical risk
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index, geopolitical threats index and geopolitical acts index). From a first look at the results
displayed in this table, we note that the response of the oil price to the various geopolitical
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risk indicators is sensitive to different market circumstances, sustaining the appropriateness

of a dependence-switching copula model. For both the positive (1=2 and 1=2) and the
negative (3 =4 and 3 =4) correlation regimes, we reject the symmetric hypothesis for each
of the considered relationships (Panels A and B of Table 4). The results also indicate that the
estimated transition probability (P11) is high (close to one), while (P00) is low, implying that the
positive correlation regime is dominant (Panel C of Table 4). Interestingly, a positive and
significant relationship between the oil returns and the changes in geopolitical risk is found
during times of high geopolitical uncertainty, whatever the level of the oil price (low or high;

17
2 and 3). This holds true when considering changes in both the global geopolitical risk
index (GPRI) and the geopolitical acts index (GPAI). However, when looking at the
relationship between the oil return and changes in the geopolitical threats index (GPTI), we
show a non-significant relationship when the oil price is high and over a rising geopolitical
risk regime.

INSERT Table 4 about here

3.3. The smoothing correlation probabilities

Figure 2 describes the smoothing probability of the positive correlation regime (the
dominant regime based on the results summarized in Panel C of Table 4). The benefit of this

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technique relies on the identification of specific times at which the correlation between the
variables seems to be positive, negligible or insignificant. We can, therefore, specify

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accurately when oil can act as a good safe haven and against which specific types of events
(i.e., threats or acts). We observe that for each of the Oil-GPRI, Oil-GPTI and Oil-GPAI
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pairs, the positive correlation regime is observed for all the times, though with different
sensitivities. These heterogeneous sensitivities raise a critical question of whether the oil
price dynamics are more correlated to the threats of adverse events, or to their realization.
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This highlights the relevance of using distinct geopolitical risk proxies to capture more
accurately how the oil price reacts to increased geopolitical uncertainty. The findings of the
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smoothing correlation probabilities, presented in Figure 2, confirm our previous results

reported in Tables 3 and 4 by revealing that oil reacts positively to heightened geopolitical
risks, and that this positive response is more apparent during geopolitical acts, in particular,
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the 1990-1991 Gulf war, the 11/09 terrorist attacks, the 2003 Iraq invasion and the 2013
Russia-Ukraine crisis.

INSERT Figure 2 about here

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3.4. The effect of geopolitical risks on the informational efficiency of the oil market
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Assuming that the efficient market hypothesis requires a significant transparency and
instantaneous reactivity with respect to new information and considering that the
informational efficiency may change with major geopolitical events, such as terrorist attacks,
wars and other important events, we try in the following to compare the effects of geopolitical
threats and realized acts on the efficiency of the crude oil market. We use a multifractal
detrended fluctuation analysis to address whether the uncertainty surrounding different
geopolitical events leads to a varying efficiency of the oil market. Figure 3 describes the

18
scaling behavior of oil returns. We observe that h(q) varies with the changes in q,
suggesting that oil returns exhibit a multifractal behavior. W e also note one crossover
point for the four log−log plots of Fq(s) vs. s.

INSERT Figure 3 about here

The crossover point can be the result of changes in the properties of the time
series at distinct scales of time. Therefore, the MF-DFA method is carried out for two
different time scales, i.e., the short-term component and long-term component of the oil price
dynamics. The results are summarized in Table 5. The range of q is allowed to vary between
−5 and 5. We show that the values of the generalized Hurst exponents h (q) are dependent
on q and are not constant, which in turn, means that oil returns possess multifractal

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characteristics6 irrespective of their short- and long-term components. Moreover, we note
that all of the generalized Hurst exponents are larger than 0.5 for the short-term components,

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implying that oil variations are likely to be persistent in the short-term. However, the
generalized Hurst exponents for the long-term components decrease depending on q,
thereby implying that the long-term behavior of oil is anti-persistent.

INSERT Table 5 about here

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We, thereafter, test the effects of the aforementioned acts and threats of the adverse
events on the underlying dynamical structure of the oil market. Table 6 reports the mean
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values of the inefficiency index based on the multifractal dimension (IDM) of oil returns during
the full sample period, before and after potential geopolitical events accounted for in the
construction of the geopolitical risk index. By definition, the oil market can be regarded as
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efficient if the value of IDM is close to zero, whereas strong IDM values indicate a less
efficient market. The short-run efficiency level is relatively lower than the long-term efficiency
level for all the cases (i.e., strong IDM values). We note that the Iranian nuclear threats and
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the escalating military and nuclear tensions between North Korea and the U.S. have not
enhanced the informational efficiency of the oil market (i.e., higher IDM values for the period
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after an announcement concerning nuclear or military threats). Hence, it seems difficult to

predict the dynamics of the oil market during periods marked by rising threats of adverse
events.
However, a sharp improvement in the efficiency level is observed after the 1990-1991
Gulf War, the invasion of Iraq and the Ukraine/ Russia crisis (i.e., the IDM values are lower in

6
The time series are driven by hidden stochastic and nonlinear components, while a single component
is not enough to describe their dynamics, thus highlighting their complexity.

19
the post-event rather than in the pre-event). These results are not surprising. As the Iraqi oil
industry is a major participant in the global energy market, a sudden decrease in Iraqi oil
production had led to supply disruptions and accordingly to an increase in oil prices. Iraq is
currently the second-largest producer of oil within the Organization of the Petroleum
Exporting Countries (OPEC), with a production of 4.3 million barrels per day. Besides, the
2013 Ukraine-Russia conflict had also driven the prices of oil. Expectedly, Russia is one of
the largest producers of crude oil and a major player in setting their own prices in the world
market. By the end of 2013, Russian annexation of Crimea has prompted a ‘cooling effect’ in
the political relations with Europe and the adoption of sequences of mutual economic
sanctions, and then a significant impact on the oil price evolution.

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INSERT Table 6 about here

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3.5. Sensitivity analysis

We now investigate how various econometric specifications and data may change our
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estimates. First, we assess how the use of futures oil prices may affect our results. Second,
we ascertain the robustness of our results by considering an alternative technique consisting
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of capturing extreme oil price changes due to unusual events. Third, we summarize recent
geopolitical risk indicators ignored in Caldara and Iacoviello (2018)’s index (namely global
trade tensions, US-China relations risks, Iran-US tensions, Gulf tensions and Venezuela
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crisis) in an aggregate proxy. The constructed composite geopolitical risk index is then
employed as a benchmark.
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3.5.1. A new proxy for the oil price

To check the robustness of the aforementioned results, we first re-examine the

correlation between oil and geopolitical risk indicators, while replacing the spot oil price by
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the futures price. The futures price of crude oil is collected from the Federal Reserve Bank of
St. Louis. Although the price of the spot contract reflects the current market price for oil, the
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futures price nevertheless reflects that the price buyers are willing to pay for oil on a dataset
at some point in the future. More accurately, an oil futures contract represents an agreement
to buy or sell a specific number of barrels of oil at a predetermined price and on a
predetermined date. Despite the possibly sharp difference between the spot market and the
futures market, modest heterogeneity in their responses to geopolitical risks is shown. More
precisely, a positive and significant effect of global geopolitical risk on futures oil prices is
shown in periods of rising geopolitical uncertainty and whatever the futures oil price level is
(see Panels A and B, Table 7). In addition, the acts exert a pronounced impact on the futures

20
oil price, whereas the effect of geopolitical menaces is likely to be modest. This outcome is
not surprising as it is hard to efficaciously predict the path of oil prices that is characterized
by its excessive volatility and vulnerability to various scenarios.

INSERT Table 7 about here

3.5.2. An alternative technique capturing oil price changes due to unexpected events
We apply a model capturing the conditional variance of returns, proposed by Maheu
and McCurdey (2004), aimed at capturing the impacts of various types of news. The latent
news process is presumed to have two dissimilar components, dubbed as normal and
unusual news events. These news innovations (normal and unusual) are identified through
their impacts on return volatility. In particular, the impact of unobservable normal news
innovations is assumed to be captured by the return innovation component (  1,t ). This

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component of the news process causes smoothly evolving changes in the conditional
variance of returns. The second component of the latent news process is assumed to

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generate large changes in returns. The effect of the unusual news events is labelled jumps
(  2,t ). An overview on this technique is offered in Appendix A.
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Table 8 presents the estimation output of the GARJI model for the oil price changes.
The mean equation coefficient µ is significant and close to zero. The equation of the GARJI
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model indicates that α, the coefficient measuring the size effect of an innovation on oil price
changes, is relatively moderate, whereas β, the coefficient corresponding to the persistence
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of volatility shocks, is high. This implies that innovations in the oil return series have a
weaker effect on the conditional variance when they arrive but persist in the memory of the
variance process for a long time. η, the coefficient referring to the leverage effect in the
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variance equation, appears positive, suggesting that negative shocks in the return series
increase volatility more than positive shocks. The jump-size standard deviation parameter,
 ,is positive and significant. The jump-size mean coefficient,  , seems negative, suggesting
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that jumps on average have a negative impact on the respective return series. Since jumps
are highly related to the arrival of unusual news, this underscores that unusual bad news
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outweighed the unusual good news. Concerning the coefficient which govern the number of
jumps and potential jump clustering, we find that the jump-persistence coefficient λ is strong
which means a great persistence in the jump intensity. The impact of innovations or

unforeseen events on the jump intensity (

 ), appears positive and significant.

INSERT Table 8 about here

Figure 4 shows that extreme changes in oil prices coincide with unforeseen
geopolitical events. Expectedly, jumps are intrinsic to the movements of financial and

21
macroeconomic variables, reflecting how the transmission of new information from different
sources affects the time series. Several key political events relevant for the demand-side
dynamics are highlighted in the figure below including : (1) the global financial crisis (an
aggregate demand shock); (2) the Libyan war (2011); (3) the Crimean crisis and the ensuing
Russian sanctions (October 2014); (4) a relative period of increased tensions between the
U.S. and China (since February 2018) that, in turn, would drag down crude oil demand,
thereby affecting its prices (we also note that in May 2019, crude oil posted a sharp
decrease, in large part because of the jump in the U.S. tariffs on China highlighted in red,
see Figure 4 below); (5) the expiration of the U.S. oil waivers that enabled China, India
among others to continue importing oil from Iran. More precisely, the U.S. asked buyers of
Iranian oil on April 2019 stop oil purchases by May 2019 or face sanctions. Such a marked
move harmed Iran’s oil revenues which in turn adversely affect oil prices; (6) the Saudi

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Arabia’ widening budget deficit and the urgent need to push oil prices up in order to balance
its budget7 ; and (7) the heightened socio-economic and political Venezuela’s crisis (January

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2019) as well as the significant increase in US shale production since the beginning of
2019. We observe from Figure 4 that the oil market have had a softened response to the
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Venezuela crisis. This is likely due to the fact that it’s uncertain what will happen over next
months. What is expected is that sanctions on Venezuela’s oil sector would have relevant
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implications for the United States. They would reduce the transactions among
U.S. companies that do business with Venezuela through purchases of crude oil and sales of
refined products. The loss of Venezuelan barrels could undoubtedly drive up crude prices
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and squeeze U.S. refineries that take in hundreds of thousands of barrels of Venezuelan oil
each day.
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We also note that various shock origins and distinct characteristics of these oil-related
events lead to different effects on oil price changes.

INSERT Figure 4 about here

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3.5.3. An extended geopolitical risk indicator

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The world continues to remain in a state of great disequilibrium, both with respect to
the global economy and geopolitics. However, the geopolitical risk index used throughout this
analysis does not account for recent geopolitical risks including the global trade war, US-Iran

7
The International Monetary Fund indicates that Saudi Arabia requires approximately $88 per barrel to
balance its budget, up from $70 per barrel in 2018. It must also be stressed that the public debt as a
percentage of GDP surged from less than 2 percent in 2014 to nearly 20 percent in 2018. Moreover, the
Saudi government projected the deficit in 2019 to be 7 percent of the country’s GDP.

22
tensions, among others. To account for recent potential events that may explain extreme oil
price movements, we develop a geopolitical uncertainty composite indicator by summarizing
Caldara and Iacoviello (2018)’s index and other recent sources of geopolitical risks, namely
global trade tensions (GTT), US-China relations risks (UCR), US-Iran tensions (URT), Saudi
Arabia uncertainty (SAU), Venezuela crisis (VC). The three first proxies are developed by the
BlackRock Investment Institute8 while identifying specific words related to recent top risks.
More specifically, they calculate the frequency of the appearance of specific keywords in
Dow Jones Global Newswire databases, Twitter and Google Trends. The country-specific
geopolitical risk indicators (in particular, for Saudi Arabia and Venezuela) were calculated by
Caldara et al. (2019). They conducted text analysis by measuring the frequency of articles in
leading newspapers by discussing rising geopolitical tensions in a particular country.

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This study conducts a Principal Components Analysis (PCA)9 in an attempt to
effectively summarize recent geopolitical risk indicators ignored in Caldara and Iacoviello
(2018)’s index (namely global trade tensions, US-China relations risks, Iran-US tensions,

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Gulf tensions and Venezuela crisis) in an aggregate proxy. The main purpose of the
constructed composite geopolitical risk index is to synthesize the impacts of distinct
-p
geopolitical risk measures within one composite measure. This allows determining more
completely the geopolitical risk’s effects on oil prices, which are not specific to one measure
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of geopolitical risk. By using this synthetic index, we prevent the idiosyncratic component that
any individual geopolitical risk measure may have. We consider monthly data stating from
January 2005 to June 2019. The starting sample period is marked by data availability (in
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particular, GTT, UCR and URT).

We attempt in the following to identify the common determining factor of the different
geopolitical uncertainty indicators (namely GPRI, GTT, UCR, URT, SAU and VC) which we
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interpret as the composite geopolitical risk index (CGRI). The correlation matrix between the
different geopolitical risk factors used is summarized in Table 9. The highest correlation is
found between the sub-indicators GPRI and UCR with a coefficient of 0.84, followed by the
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correlation among GTT and UCR with a coefficient of 0.72. The geopolitical risk indicators
are likely to move together, implying that there is a common geopolitical risk component to all
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these proxies. We thereafter seek to identify this common component by developing a

geopolitical risk composite indicator using the PCA.
INSERT Table 9 about here
Table 10 summarizes the descriptive statistics for the geopolitical risk composite
index derived from PCA. We find a positive and pronounced relationship among most

8
The data are available via this link: https://www.blackrock.com/corporate/insights/blackrock-
investment-institute/interactive charts/geopolitical-risk-dashboard
9
Details about the Principal Component Analysis (PCA) are provided in Appendix B.

23
geopolitical risk proxies and the composite index, implying that all the sub-indicators play a
significant role in explaining the common uncertainty dynamics. The common variation in
geopolitical risk is strongly explained by GTT and UCR.

INSERT Table 10 about here

Figure 5 depicts the composite geopolitical risk index derived from PCA. We clearly
observe that the index peaks coincide with specific geopolitical risk events including the
Eurozone sovereign debt crisis, the Arab Spring and the Libya war (Start 2011), the Crimea
invasion (end 2013), the continued China’s economic slowdown (mid-2015), the 2016 U.S.
presidential elections and Trump nomination (November 2016), heightened Gulf tensions (in
particular, Qatar-Gulf diplomatic crisis, June 2017), the US-China trade war (since February

of
2018), the increased US-Iran tensions (November 2018) and the 2019 Venezuelan
presidential crisis and the additional economic sanctions applied by the United States to

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Venezuelan petroleum and mining industries (January 2019).

INSERT Figure 5 about here

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Table 11 reports the estimated parameters of the regression of oil returns and the
constructed composite geopolitical risk index (CGRI), using a dependence-switching copula
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model. For investors wanting to use these safe haven characteristics of oil to protect against
changes in geopolitical risks, it is very useful to discover whether the responses of oil to
CGRI is consistent across all states or concentrated in particular times of geopolitical stress.
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This study assesses this property by accounting for periods of high and low geopolitical risks
and various oil price nuances. We robustly find that oil prices increase significantly amid
heightened geopolitical risk (i.e., in high risk scenarios) whatever the level of the oil price (2
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and3, see Panels A and B, Table 11). This strongly suggests that holding a diversified
portfolio composed of oil could help safeguarding against the exposure to unforeseen
geopolitical risks.
ur

INSERT Table 11 about here

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Summing up, these results appear very timely and useful for both individual and
institutional investors as the global oil market continues to be persistently rocked by
unpredictable and extremely destabilizing events. In today’s uncertain environment,
measuring the price dynamics of oil, called a ‘black gold’, and is also known by its safe haven
feature, under different scenarios becomes fundamental in designing sensible risk
management strategies. When the situations of high uncertainty occur, an effective

24
defense is to be well informed. The different econometric tools used in this paper help to
detail the risk-facing market participants by providing them with precise information on
different states, especially on how to deal with the worst case conditions (i.e., times of high
uncertainty).

3.6. Discussion of the results

The present study complements the existing literature on the dynamic dependence
between the returns of oil and those of other asset classes during uncertain periods, and that
on the effects of wars, terror attacks, and other forms of collective violence on oil price
dynamics (see, for example, Kollias et al., 2013). Regardless of the paramount importance of
such analyses, we believe that the examination of the direct effect of geopolitical uncertainty

of
on oil price movements may provide fresh and more accurate insights into this debated
issue. The present paper makes an attempt to investigate the dynamic dependence between

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oil returns and newly relevant geopolitical risk indicators.

Our results reveal a positive and strong relationship between oil returns and changes
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in geopolitical risk (with large geopolitical acts) in periods of high uncertainty, and regardless
of the level of the oil price. This finding is highly expected as geopolitical risks cause
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disruptions in major oil-producing countries, raising critical questions about the ability of
these countries to supply the global market in the long-term in periods of heightened crises
or tensions which would have a strong effect on the oil price evolution. Such a positive
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response of oil prices also highlights that oil may be a good option for investors who seek
insurance against geopolitical uncertainty. Oil has been long called ‘black gold’ and some
analysts argue that oil may replace gold as a safe haven asset for various reasons. For oil,
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unlike gold, there are supply and demand factors related to an economy producing goods
and services that result in how much oil is utilized. From this, the price of oil is highly
influential. In addition, the oil market is much more liquid and much more varied than that of
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the yellow metal. Due to the extensive way that oil is used in the global world and the
extensive availability of financial instruments that can achieve efficient hedging of oil
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price risk exposure, the purchasing power of a barrel of oil is likely to be stable.
Nevertheless, the effect of threats of adverse events on oil price dynamics appears
much less pronounced or non-significant. This can be attributed to the excessive volatility,
the multifractility and the inefficiency of the oil market. Given these oil market features, it
does not seem easy to invest in this market. This difficulty becomes more perceptible given
the current heightened political risks which have exacerbated uncertainty. If the markets
effectively manage the acts (that is, they succeed to efficaciously minimize the impact of
wars and terrorist acts on prices), it is still difficult to deal with increased geopolitical threats,

25
especially with the increases in populist challenges. Nowadays, the global rise of populism
(particularly, in the United States and Europe) is one of the biggest challenges facing the oil
and financial markets.
Although our findings show that political threats have so far been well anticipated, we
must recognize that we are only at the beginning of a very long process where uncertainty
reigns supreme in the future. Sudden shifts from a low or normal dependence regime to a
high or crash dependence regime can be perceived as a reflection of systemic shocks. Add
to this the information (or signals) received by the economic agents which is generally
supposed to be noisy; that is, the news may turn out to be validated by future events or may
be wrong in the sense that future developments or investment decisions may not conform to
the content of the original information. In those cases, the anticipated consequences will not

of
materialize and then the investment decisions might be afflicted. Hence, comes the efficacy
of the copula-based approaches, enabling a flexible and realistic modelling far from the
simplistic assumptions such as normality and linear dependence.

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4. Conclusions
-p
The purpose of this paper is three-fold. The first is to assess if oil can be a good
option for investors who seek insurance during episodes of rising geopolitical tensions. The
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second is to address whether the effects of higher geopolitical risk on oil price dynamics are
more reactive to threats of adverse events or to their realization (i.e., geopolitical acts).
Assuming then that the informational efficiency may vary with potential geopolitical events, a
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third objective is to examine the effects of geopolitical risks on the informational efficiency of
the oil market. We use flexible econometric techniques, namely the Markov-switching model,
the dependence-switching copula and the multifractal detrended fluctuation analysis (MDF),
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which incorporate multiple features that set this paper apart from the literature on the role of
geopolitics in determining oil price dynamics. Several sensitivity tests have been conducted
to ascertain the robustness of our findings.
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Our results indicate that there exists a positive and pronounced relationship between
oil returns and changes in geopolitical risk during periods of rising geopolitical uncertainty,
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whatever the level of the oil price. A positive and strong relationship is highly expected when
the countries at war are major suppliers or consumers of oil. For instance, when a country
that supplies a wider portion of the world’s oil goes to war, the uncertainty with respect to the
level of the world’s oil reserves would increase substantially. Since the demand for oil would
continue to increase and the supply would be uncertain, a country unable to produce enough
oil within its own borders would be required to ensure that enough oil was stored to cover
operations, thus causing a surge in oil prices.

26
 However, a non-significant relationship between the threats of adverse geopolitical
events and the oil price is shown. In light of the past history of oil supply disruptions resulting
from geopolitical events, the market participants are often evaluating the possibility of future
disruptions and their possible consequences. Besides the size and the persistence of a
potential disruption, those participants also take into consideration the ability of the non-
affected producers to counterbalance a probable supply loss. Such factors might help to
absorb the effects of threats on oil prices.

Another potential factor for the oil market to reckon with will be the significant role
played by the Organization of the Petroleum Exporting Countries (OPEC) in cooperation with
Russia and other non-OPEC oil exporters. The OPEC’s main objective is to preserve the
stability of the oil market, meaning that OPEC would safeguard an oil price floor. But it must

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be pointed out here that there is a limit on the extent to which OPEC and others can defend
the oil price. In circumstances of global recessions, falling oil demand and rising global oil

ro
supply, it would be difficult for the organization to defend a high price for too long. The short-
term needs of OPEC member countries could countermand their long-term priorities and
break their production discipline, thus prompting an over-production and a consequent sharp
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decline in the price of oil. Nevertheless, OPEC’s budgets might spur OPEC actions to arrest
the collapse of the price of oil and maintain it at a level deemed reasonable.
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Recently, the effects of tariffs on Chinese goods, sanctions on Venezuela’s oil
industries, and Saudi Arabia’ widening budget deficit, as well as the recent agreement by the
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OPEC and other countries to cut production (June 2019) underscore that geopolitics could
have a significant impact on oil prices over the next months and maybe years. More
importantly, the escalation in the rift between the U.S. and Iran is showing no signs of
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collapsing. Risks for oil prices could be more pronounced if Tehran takes actions in
attempting to shut down the Strait of Hormuz, which is a very prominent transit point for more
than 20 percent of the global crude oil trade. This opens the door for further research on the
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effect of policy responses to U.S. sanctions from Iranian officials. It remains also unclear
whether Venezuela’s Maduro government can mitigate the detrimental consequences of the
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recent U.S. sanctions by seeking partnerships with friendly countries. For instance, China
and Russia continue to provide political and economic support for the Maduro administration,
regardless of the U.S. sanctions. It’s a matter of time until we are able to have sufficient
information about the consequences of the U.S. sanctions on Iran and Venezuela. At the
moment, we still don’t know what will happen in the future.

1Acknowledgement: The authors would like to thank the editor-in-chief Professor Richard S.J. Tol, the
associate editor Professor Ugur Soytas and the two anonymous Reviewers for helpful and constructive
comments on an earlier version of this article.

27
Appendix A. Extraction of oil price jumps due to unexpected events

Maheu and McCurdy (2004) have proposed an autoregressive conditional jump intensity
framework combined with a generalized autoregressive conditional heteroskedasticity
(GARCH) model, termed GARJI model. The latter consists of identifying the “hidden”
components of returns. Given information set at time t- 1, which consists of the history of

returns t 1  rt 1 ,..., r1 , the two stochastic innovations  1,t and  2 ,t determine the returns,

rt     1,t   2,t (a.1)

where  1,t is specified as a normal GARCH error term such that E[ 1,t t 1 ]  0 ,  2 ,t
is a

of
jump innovation with a normal stochastic forcing process such that E[ 2,t t 1 ]  0 ,  1,t is

contemporaneously independent of  2,t .

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The conditional variance of returns is disentangled into two components, namely a smoothly
evolving conditional variance component associated with the diffusion of past news effects,
-p
and the conditional variance component related to the heterogeneous information arrival
process which induces jumps. The conditional variance of returns is
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Var (rt t 1 )  Var ( 1,t t 1 )  Var ( 2,t t 1 ) (a.2)
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The first component of the conditional variance,  t2  Var ( 1,t t 1 ) is expressed as a

GARCH function of past return innovations,

 t2    g (  t 1 )   t21   t21 (a.3)

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where g(·) is a function of the parameter vector  or the feedback coefficient from past return

innovations, and  t 1   1,t 1   2,t 1 is the total return innovation observed at time t-1. The
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GARCH volatility component enables past shocks to exert influence on expected volatility
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and detects thereafter the smooth autoregressive changes in the conditional variance that
are predictable based on past news impacts.

The second component or the conditional variance component associated with the jump
innovation is denoted as

Var ( 2,t t 1 )  (   )t (a.4)

28
where  refers to the number of jumps and potential jump clustering or the jump-persistence
coefficient,  is the jump-size standard deviation parameter, and  t is the conditional jump
intensity. Based on Equation (a.4), the contribution to the conditional variance from jumps will
change over time as the conditional intensity varies. Note that the conditional jump intensity

 t is presumed to be autoregressive and associated with last period’s conditional intensity as

well as to an intensity residual ξt−1.

Appendix B. A brief overview on the Principal Component Analysis

The PCA aims at determining how various variables change in relation to each other, or how

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they are related. This is attained by transforming correlated original variables into a new set
of uncorrelated time series using the correlation matrix. The new variables are linear

ro
combinations of the original ones and are sorted into descending order based on the amount
of variance they explain of the original set of series. In other words, the main objective of the
-p
PCA investigation is to take Q variables to x1, x2 ...xQ and find linear combinations of these,
allowing one to generate the principal components Z1 , Z2 ,...ZQ that are uncorrelated
following:
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Z1  a11 x1  a12 x 2  ... a1Q xQ (a.5)
.Z 2  a 21 x1  a 22 x 2  ... a 2Q xQ (a.6)
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.
.
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Z Q  aQ1 x1  a1Q 2 x 2  ...  aQQ xQ (a.7)

The next step is to choose the principal components that preserve the greatest
amount of the cumulative variance of the original data. Note that the relatively moderate
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correlation in the principal components is a good feature as it implies that the principal
components represent distinct statistical dimensions in the dataset.
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The weights aij applied to the series xj in Equations (a.5), (a.6) and (a.7) are selected
so that the principal components Zi satisfy two main conditions : (i) they are uncorrelated, and
(ii) the first principal component represents the maximum portion of the variance of the data,
whereas the second principal component accounts for the maximum of the remaining
variance.

29
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Figure 1. Monthly oil returns and changes in geopolitical risk indices
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Figure 2. Smoothing probabilities of the positive correlation regime: Oil-GPRI, Oil-GPTI and
Oil-GPAI pairs

34
 of
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.19
Figure 3. Dynamic returns, multifractal spectrum and the curve of Fq(s) vs. s in a log-
log plot of oil returns
-p Global financial crisis Feb 2018: Mr. Trump announces
re
.18 first traiffs on China goods

.17 1990-1991 Gulf war Crimean crisis Nov 2018: Sanctions targeting
Iran's energy sector
.16
9/11 terror attack North Korea and Iran nuclear threats
lP

Jan 2019: Sanctions on

.15 Venezuela's oil industry
and noticeable rise in
.14 USshale production
2003 Iraq invasion
.13

.12
na

.11
Arab Spring/Libyan war
.10
June 2017: Qatar
.09 diplomatic crisis
ur

.08

.07

.06
2019: Saudi Arabia'
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.05 widening budget

deficit
.04
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Oil price jumps

Figure 4. Extracted oil price jumps due to unforeseen geopolitical events

35
.28
Eurozone debt crisis Crimean crisis and Feb 2018: US-China
Russia sanctions trade tensions
.26
Trump's win
.24 China's slowdown
End 2018/Start 2019:
Increased US-Iran tensions
.22 Arab Spring and Libya war and Venezuela crisis

.20

.18

.16 June 2017:Qatar-Gulf

diplomatic crisis
.14

.12
I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I I I IV I I

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Figure 5. PCA : The evolution of the composite geopolitical risk index

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Table 1. Descriptive statistics of the return series
Oil GPRI GPTI GPAI
Mean -0.0037 0.0599 0.0168 0.0810
Median -0.0027 0.0766 0.0808 0.0721
Std. Dev. 4.0486 4.0378 3.0458 3.0346
Skewness -0.2351 -0.0380 -0. 1764 0. 5006
Kurtosis 6.0366 4.6392 4. 5175 4. 6639
Jarque-Bera 78.682*** 11.439*** 15.855*** 24. 822***
Note: Std. Dev. symbolizes the standard deviation; The asterisk *** denotes the significance of the rejection of
normality at the 1% level.

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 Table 2. The BDS test based on the residuals of the monthly return series
Dimensions m=2 m=3 m=4 m=5 m=6
The dependent variable
Oil 1.9703** 2.9304** 3.1552*** 3.0925** 2.9250***
[0.0088] [0.0011] [0.0009] [0.0021] [0.0008]
The independent variables
GPRI 5.7185*** 6.0511*** 7.4964*** 8.7352*** 9.8141***
[0.0000] [0.0000] [0.0000] [0.0000] [0.0000]
**
GPTI 2.1368 3.1831** 3.1546** 2.3768*** 3.1267**
[0.0074] [0.0068] [0.0081] [0.0004] [0.0054]
*** *** *** ***
GPAI 5.2283 7.9248 9.5910 10.5393 11.5138***
[0.0000] [0.0000] [0.0000] [0.0000] [0.0000]
Notes: The entries indicate the results of the BDS test based on the residuals of oil returns and changes in
different geopolitical risk indices in a VAR. m denotes the embedding dimension of the BDS test. ***, ** and *
indicate the rejection of the null of the residuals being iid at the 1%, 5% and 10% levels of significance,
respectively.

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 Table 3. Estimation of the dynamic copula with Markov-switching: Oil and geopolitical
risks
Oil-GPRI Oil-GPTI Oil-GPA
H 0.2132***
(0.0005)
0.0932
(0.1568)
0.1983*
(0.068)
L 0.0134*
(0.0378)
0.0168
(0.3541)
0.0119*
(0.0594)
 0.1612*** 0.0913*** 0.1726*
(0.0004) (0.0000) (0.0385)
 0.3456** 0.1092*** 0.3231*
(0.0011) (0.0001) (0.0106)
πHH 0.9346** 0.3972* 0.6235***
(0.0052) (0.0109) (0.0000)
πLL 0.2817*** 0.8613** 0.3745**
(0.0001) (0.0054) (0.0357)
Notes: Superscript H (L) indicates the high (low) dependence regime. πHH (πLL) is the probability of staying in the

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high (low) dependence regime. ***, ** and * denote significance at the1%, 5% and 10% levels, respectively.

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Table 4. Estimation of the dependence-switching copula model: Oil and geopolitical risks
Oil-GPRI Oil-GPTI Oil-GPAI
Panel A. A positive correlation regime
A low level of oil price associated with an episode of falling geopolitical risk
1 0.39245* 0.35621*** 0.34689***
1 0.34567** 0.31426** 0.33107***
1 0.08915*** -0.0914 0.08345**
A high level of oil price associated with an episode of rising geopolitical risk
2 0.33891** 0.19863*** 0.10983**
2 0.21456* 0.18654* 0.096783**
2 0.19046*** 0.10793 0.09672**
Panel B. A negative correlation regime
A low level of oil price associated with an episode of rising geopolitical risk
3 0.24561 0.18953** 0.134512

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3 0.19865* 0.15741 0.224179
3 0.06346** -0.06652 0.10246***
A high level of oil price associated with an episode of falling geopolitical risk

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4 0.13456* 0.10653* 0.11456
4 0.12451* 0.07952** 0.09821**
0.00124* 0.00342*
4
Panel C. Regime switching
P11 0.9945***
-0.00762

0.9642***
-p 0.9856**
re
P00 0.3452*** 0.3823*** 0.4972*
Notes: *, ** and*** refer to statistical significance at the 10%, 5% and 1% levels, respectively;  is the shapee
parameter;  is the correlation coefficient;  is the tail dependence parameter; P11 is the probability of
staying in the positive correlation regime; P00 is the probability of staying in the negative correlation
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regime.
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Table 5. The generalized Hurst exponents of oil returns

Original series: Oil returns

q Short-term Long-term
-5 0.6623 0.6197
-4 0.6945 0.6289
-3 0.6029 0.6234
-2 0.5873 0.6014
-1 0.5366 0.5324
0 0.6013 0.5014
1 0.6258 0.3827
2 0.5843 0.3456
3 0.6342 0.3087
4 0.6651 0.2591
5 0.6728 0.2817

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 Table 6. IDM mean values prior and post- specific geopolitical threats and acts

GPTI GPAI
North Korea’s Iranian U.S-North Gulf War 9/11 attack 2003 Ukraine/Russia
nuclear menace nuclear Korea Invasion of crisis
threats military Iraq
tensions
Before After Before After Before After Before After Before After Before After Before After
Short- 0.128 0.139 0.108 0.117 0.151 113 0.137 0.108 0.136 0.069 0.151 113 0.154 0.131
term
Long- 0.135 0.144 0.123 0.136 0.167 142 0.161 0.124 0.144 0.077 0.167 142 0.169 0.144
term

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Table 7. Estimation of the dependence-switching copula model: Futures oil prices and the
geopolitical risks

Oil-GPRI Oil-GPTI Oil-GPAI

Panel A. A positive correlation regime
A low level of oil price associated with an episode of falling geopolitical risk
1 0.2651** 0.2189** 0.2761**
1 0.2397** 0.1694*** 0.2589***
1 0.1872*** 0.0761** 0.1451*
A high level of oil price associated with an episode of rising geopolitical risk
2 0.3184*** 0.1173*** 0.1345***
2 0.1678** 0.2156** 0.1156***
2 0.4918** 0.0249* 0.2178**
Panel B. A negative correlation regime
A low level of oil price associated with an episode of rising geopolitical risk
3

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0.2245*** 0.1544*** 0.1739**
3 0.1983*** 0.1762* 0.2032**
3 0.2341** 0.0934 0.1346***

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A high level of oil price associated with an episode of falling geopolitical risk
4 0.0782** 0.1134*** 0.1456*
4 0.0982** 0.0932*** 0.1232
4 0.0045*** 0.0007* -p 0.0314
Panel C. Regime switching
P11 0.9782*** 0.9943*** 0.9761***
P00 0.2278** 0.1955** 0.3144***
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Notes: *, ** and*** refer to statistical significance at the 10%, 5% and 1% levels, respectively; is  is the shape
parameter;  is the correlation coefficient;  is the tail dependence parameter; P11 is the probability of staying
in the positive correlation regime; P00 is the probability of staying in the negative correlation regime
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 Table 8. Oil price jumps: stimulation output of the GARJI model
Mean Equation
 -0.3572**
(0.0068)
rt 1 0.0139***
(0.0001)
Variance Equation
 5.3178*
(0.0114)
 0.0143**
(0.0038)
 0.4216**
(0.0013)
 0.2341*

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(0.0175)
 0.1345***
(0.0002)


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-0.1928*
(0.0136)
 0.6973*
(0.0110)
 0.1244*
(0.0321)
-p
Notes: ***, ** and * imply significance at the 1%, 5% and 10% levels, respectively;
rt 1 refers to
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the lagged oil price returns;  is the size effect of an innovation ;  measures the persistence of

 denotes the leverage effect ; 

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volatility shocks; corresponds to the jump-size standard deviation


parameter ;  refers to the jump-size mean;  corresponds to the jump-persistence coefficient ; measures the

jump intensity
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Table 9. PCA : The correlation matrix between different geopolitical risk indicators
GPRI GTT UCR URT SAU VC
GPRI 1 0.51723 0.84231 0.56781 0.62417 0.55623
GTT 1 0.72451 0.55042 0.36821 0.59349
UCR 1 0.20342 0.24178 0.41942
URT 1 0.21552 0.18764
SAU 1 0.27692
VC 1
Notes : GTT is global trade tensions, UCR is US-China relations risks, URT is US-Iran tensions, SAU is Saudi
Arabia uncertainty, VC is Venezuela crisis.

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Table 10. PCA : The descriptive statistics for the composite geopolitical risk index
CGRI
Basic statistics
Mean 0.03478
Std.Dev. 0.10134
Skewness 0.91560
Kurtosis 3.24518
Correlations
GPRI 0.69
GTT 0.81
UCR 0.80
URT 0.71
SAU 0.68
VC 0.72

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Notes: GTT is global trade tensions, UCR is US-China relations risks, URT is US-Iran tensions, SAU is Saudi
Arabia uncertainty, VC is Venezuela crisis.

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 Table 11. Estimation of the dependence-switching copula model: Oil and the composite
geopolitical risk index

Oil-CGRI
Panel A. A positive correlation regime
A low level of oil price associated with an episode of falling geopolitical risk
1 0.1678***
1 0.2451***
1 0.03451
A high level of oil price associated with an episode of rising geopolitical risk
2 0.1875***
2 0.2410**
2 0.2169***
Panel B. A negative correlation regime
A low level of oil price associated with an episode of rising geopolitical risk

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3 0.2218**
3 0.2037***
3 0.1972***

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A high level of oil price associated with an episode of falling geopolitical risk
4 0.0762
4 0.1181*
4
Panel C. Regime switching
P11
0.1019

0.8172***
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P00 0.2594**

Notes: *, ** and*** refer to statistical significance at the 10%, 5% and 1% levels, respectively; is  is the shape
parameter;  is the correlation coefficient;  is the tail dependence parameter; P11 is the probability of staying
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in the positive correlation regime; P00 is the probability of staying in the negative correlation regime. .
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