Global Financial Stability Report

Chapter 2: Geopolitical Risks: Implications for Asset Prices and Financial Stability

Geopolitical risk events generally exert a modest influence on asset prices. However, major events, such as military conflicts, can lead to substantial decline in stock prices and raise sovereign risk premiums. The impact is particularly pronounced in emerging markets that have limited fiscal space or international reserve buffers. Geopolitical risks can also propagate to other countries through trade and financial linkages. While investors appear to price geopolitical risk into equity and option markets to some extent, the materialization of these risks can trigger financial market volatility. A sudden, major geopolitical risk event could also weigh on the stability of banks and nonbank financial institutions, potentially posing a risk to macrofinancial stability. To mitigate financial stability risks arising from geopolitical events, financial institutions and their oversight bodies should allocate sufficient resources to identify, quantify, and manage these risks, including through stress testing and scenario analysis. Emerging market and developing economies should continue efforts to develop and deepen financial markets and maintain adequate fiscal policy space and international reserves to cushion against adverse geopolitical shocks.