Geopolitical shocks and macro‑financial tail risks in Europe
This report proposes a new monitoring framework covering 40 geopolitical indicators and finds that geopolitical factors reduced lower-tail GDP growth by 1–2 pp since 2014.
Methodology
- Risk taxonomy and indicators: The ESRB/ECB team define five geopolitical/geoeconomic risk categories: (i) military conflicts and wars; (ii) infrastructure vulnerabilities (energy and digital); (iii) trade disruptions and sanctions; (iv) capital and financial risks; and (v) political/societal factors. They then construct a set of 40 indicators (market‑based, cyclical, and structural) and summarize them in a GEO heatmap for regular monitoring.
- Growth‑at‑Risk (GaR) modelling: They estimate panel GaR models for EU countries, adding one indicator per geopolitical category (EPU, GPR, WTO trade disputes index, capital‑markets volatility, migration‑fear index) alongside systemic‑risk and financial‑stress measures to quantify how these risks shift the lower tail of the GDP growth distribution.
- Transmission and stress tests: They use econometric models and scenario analysis to trace how geopolitical shocks affect macro‑financial variables (financial conditions, loan growth, systemic stress) across EU Member States, and run macro‑financial stress‑test style simulations to assess how soundness and capitalization of the financial system amplify or dampen the effects.
Findings
- Geopolitical/geoeconomic risks have intensified: Indicators for geoeconomic fragmentation, geopolitical tensions and policy uncertainty have risen notably since 2014, with policy uncertainty surging in 2024–25 and WTO trade disputes up about 27% over 2015–24.
- Downside growth risks: Including geopolitical indicators in the GaR framework lowers expected GDP at the 10th percentile by roughly 1–2 percentage points compared with models without such risk factors; geopolitical risks increasingly act as a drag on lower‑tail growth.
- Financial‑stability transmission: Heightened geopolitical and policy‑uncertainty shocks raise systemic stress, reduce loan growth and tighten lending conditions, creating significant tail risks for the real economy.
- Heterogeneous vulnerability: EU economies with higher trade openness or higher public debt are more vulnerable to amplification effects, and geopolitical risk can reduce financial integration and business‑cycle synchronization in the euro area, thereby magnifying output and financial stress.
- Role of a strong financial system: Scenario analyses and stress tests show that well‑capitalised, resilient banks and financial institutions can materially limit adverse macro‑financial outcomes, acting as a stabilizing buffer against geopolitical shocks.
Financial stability risks from geoeconomic fragmentation
From: ESRB/ECB
Global tensions reprice sovereign risk through different channels
How do geopolitical and geoeconomic shocks reprice sovereign credit risk, and through which distinct transmission channels (default risk, global financial conditions, uncertainty, and domestic factors) do these shocks operate? This is the question Alvaro Ortiz, Tomasa Rodrigo, and Pablo Saborido analyze in this paper.
The authors define four channels for sovereign CDS spreads: Direct (default risk), Global Financial Cycle (GFC), Uncertainty, and Local/domestic. They estimate a nonlinear machine‑learning (ML) model of daily CDS spreads using news‑based indicators of geopolitical risk, economic policy uncertainty, trade policy uncertainty, and domestic political sentiment, plus standard financial variables. They apply a Shapley–Taylor decomposition to the ML predictions to quantify how much each channel contributes to spreads for each country and day. Finally, Ortiz et al. validate the channel taxonomy with event‑study local projections around major geopolitical and geoeconomic episodes and a complementary sign‑restricted VAR that does not rely on the ML decomposition.
Findings
- Different transmission for different shocks: Geopolitical shocks (wars, major security crises) directly increase the sovereign default premium, but at the same time they tend to trigger easier global financial conditions, which partly compress spreads again. This opposing movement is what the authors call the “scissors pattern.” In contrast, geoeconomic shocks (sanctions, tariffs, trade policy changes) do not mainly work through default risk; instead they show up as changes in global financial conditions, policy uncertainty, and country‑specific domestic factors, with only a small direct effect on the sovereign default premium.
- Nonlinearity matters: The authors find that sovereign CDS spreads react to news in a way that depends on the level of risk and country conditions. Only nonlinear models that allow for interactions and regime changes can capture this; simple linear models miss most of the predictive power in the news indicators.
- Event‑level validation: When the authors run narrative local projections around major events, the Russia–Ukraine war clearly shows the “scissors pattern” and their model correctly predicts the direction of effects in 15 out of 16 cases, a result that is statistically very robust.
Geopolitics, Geoeconomics, and sovereign risk: Different shocks, different channels
Authors: Alvaro Ortiz, Tomasa Rodrigo, Pablo Saborido
From: BBVA Research
