Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk): formula sheet

Key formulas

GPR index construction

GPR(t) = [articles in period t matching geopolitical-risk terms ÷ all articles in period t] × scaling constant

The constant is chosen so the 2000-2009 average equals 100. Verbal construction is what the exam tests, not computation of raw counts.

Reading the index level

Index value ÷ 100 = multiple of the 2000-2009 average level of geopolitical coverage

A value of 200 means coverage share is twice the base-period average. It is not 'twice the actual risk' in a loss sense.

Percentage change

% change = (GPR new − GPR old) ÷ GPR old × 100

Use this to compare a spike with the prior level.

Threats vs acts

Threats = war threats, peace threats, military buildups, nuclear threats, terror threats. Acts = beginning of war, escalation of war, terror acts

Threats are risks that an event may occur. Acts are events that have occurred.

Limitations to remember

News-based proxy: measures attention, not direction, loss or probability

It depends on which newspapers and keywords are used, and media attention can lag or exaggerate events.

Required return decomposition

Expected return = Risk-free rate + Risk premium

Geopolitical risk can raise the risk premium and cut expected cash flows. Both lower the asset price.

Bond yield decomposition

Bond yield = Benchmark yield + Credit (or sovereign) spread

Geopolitical stress usually widens the spread. A flight to safety can lower the benchmark yield at the same time.

Approximate bond price change

ΔP ÷ P ≈ −Modified duration × Δy

Use this to turn a spread move into a price loss. Use the change in the bond's own yield.

Expected Shortfall

ES(α) = average loss given that loss ≥ VaR(α)

Captures tail risk. Geopolitical risk shows up more in ES than in average returns.

GPR index idea

GPR = share of news articles discussing adverse geopolitical events, scaled to an index

A news-based measure of perceived risk. A rise means higher perceived risk, not a realised loss.

Channel map

Shock → credit | funding | market liquidity | sanctions | volatility → balance sheet loss or liquidity strain

Use this to classify any scenario. Name the channel first, then the institution type.

Bank vs NBFI emphasis

Banks: loans, deposits, wholesale funding. NBFIs: asset prices, redemptions, leverage.

A rule of emphasis, not an absolute. Both types face all channels to some degree.

Amplification loop

Price fall → margin calls or outflows → forced sales → further price fall

Strongest where leverage or liquidity mismatch is high.

Shock transmission chain

Geopolitical shock → higher uncertainty → lower risk appetite → portfolio outflows → wider spreads and weaker currency → tighter financial conditions

A qualitative chain to use in scenario questions. The report does not give a formula.

Amplification rule

Impact on flows and spreads ≈ size of shock × level of preexisting vulnerabilities

A memory aid, not a formal equation. A weak starting position raises the response to the same shock.

Portfolio flow

Net flow = foreign purchases − foreign sales

A negative value is an outflow. Flows are often scaled to GDP or to fund assets for comparison.

Spread change

Change in spread (bp) = new spread − old spread

Use basis points. 1 bp = 0.01%.

Risk-management chain

Shock → transmission channel → exposure → tool

Use this to match any geopolitical question to the correct response.

Stress test capital check

Post-stress capital ratio = (Capital − stress losses) ÷ Risk-weighted assets

Simplified. Real tests also adjust RWA and revenue. Compare the result with the minimum plus buffers.

Liquidity Coverage Ratio

LCR = Stock of high-quality liquid assets ÷ Total net cash outflows over 30 days ≥ 100%

A standard Basel liquidity buffer test. It is a regulatory minimum, not a geopolitical scenario by itself.

Reverse stress test

Start from failure outcome → find scenario that causes it

Works backwards. Useful where history gives no guide to a rare event.

Quick revision

• Geopolitical risk covers events such as conflict, sanctions, terrorism and trade tension that can disrupt markets and the economy.
• GPR-type indices are built from counts of news articles on geopolitical tension, so they capture perceived risk.
• A higher index reading is linked with weaker asset prices and higher volatility, and the effect varies by asset and country.
• Tail risk matters: geopolitical shocks can widen the left tail of returns more than they move the average.
• Institutions face the shock through market losses, credit losses, funding and liquidity strain, and operational disruption.
• Sanctions and cross-border exposures create credit and counterparty risk that is hard to hedge.
• Investors can cut risk quickly, which drives portfolio outflows and can hurt more vulnerable markets.
• Leverage, liquidity mismatch and concentration act as amplifiers of the initial shock.
• Nonbank financial institutions can transmit stress as well as banks.
• Policy tools include stress testing, adequate capital and liquidity buffers, and close supervisory monitoring.
• Firms should include geopolitical scenarios in stress tests and review concentrated exposures.
• Read the question for the channel first, then match the risk type and the response.

Common mistakes

• Saying the GPR index is built from market prices or volatility. Fix: Remember it is a text-search index: a share of newspaper articles.
• Classifying a terror attack that has happened as a threat. Fix: Ask whether the event occurred. Terror acts are acts. Terror threats are threats.
• Saying all assets fall when geopolitical risk rises. Fix: Separate risky assets (equities, emerging market debt) from safe havens (gold, high-quality government bonds, some currencies) and from commodities exposed to supply threats.
• Treating the effect as uniform across countries. Fix: Always check country strength, own versus spillover risk, trade and energy links, and sector before choosing the direction.
• Treating geopolitical risk as only a credit risk problem. Fix: Always scan for funding, liquidity, sanctions and volatility channels as well.
• Assuming NBFIs are not affected because they are not banks. Fix: NBFIs are exposed through asset prices, redemptions and leverage, and can pass stress back to banks.
• Assuming all investors react the same way to geopolitical risk. Fix: Separate fast, redemption-prone or benchmark-driven investors from long-horizon holders, and say reactions tend to differ.
• Treating geopolitical shocks as affecting all emerging markets equally. Fix: Look for country-specific vulnerabilities such as debt levels, reserves and reliance on foreign funding.
• Relying on historical VaR to measure geopolitical risk. Fix: Remember geopolitical events are rare and regime-changing. Use scenario analysis and stress testing, with VaR as a complement.
• Treating stress testing and scenario analysis as identical. Fix: Scenario analysis builds the story and its transmission. Stress testing applies the shocks to portfolios, capital and liquidity to measure results.

Exam tips

• Expect questions that ask which items are threats and which are acts. Memorise the eight categories as 5 threats and 3 acts.
• Watch for options that call the GPR a market-based or loss-based measure. It is a news-count index.
• Questions often test interpretation, so choose the answer that links the index to attention and uncertainty, not to guaranteed price moves.
• Know that the index is scaled to 100 for 2000-2009, and be ready to convert a value to a multiple or percentage change.
• Link the measure to its use: early warning, scenario design and stress testing.
• Expect conceptual questions with four plausible statements. The right one usually has a direction and a condition. Wrong ones use always, never or only.
• Link geopolitical risk to tail measures. If the question mentions Expected Shortfall, stress losses or left-tail risk, the chapter's tail-risk finding is probably the point.
• Remember emerging markets are generally more exposed through wider spreads, but check the case for fiscal and financial strength before assuming it.