FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

Geopolitical Risk and Its Impact on Asset Prices

Updated 11 October 2026 · Fact-checked

Geopolitical risk is the risk from wars, terrorism and tensions between states. In the IMF's April 2025 GFSR, higher geopolitical risk tends to lower equity returns, raise downside tail risk and widen risk premia, especially in emerging markets. To solve questions, identify the asset, the channel, the country or sector, and the direction.

Understand Geopolitical Risk and Asset Price Impact

Geopolitical risk is the risk that wars, terrorism, sanctions, trade conflict or political tension between states disrupts economies and markets. It is hard to measure because it is not a price. The chapter uses a news-based index, the GPR index (Caldara and Iacoviello), which tracks how often newspapers discuss adverse geopolitical events. A higher reading means more perceived risk.

Start from the pricing idea. An asset's expected return is the risk-free rate plus a risk premium. Geopolitical shocks can hit both parts. They can lower expected cash flows (damaged trade, higher costs). They can also raise the premium investors demand, because outcomes become more uncertain and bad outcomes become more likely. Higher premia mean lower prices today.

The chapter's main message on equities is that rising geopolitical risk is linked to lower average returns and, more importantly, fatter downside tail risk. Bad outcomes become more likely than the average effect suggests. This is why the topic ties to Expected Shortfall and stress testing, not just to volatility.

Other assets react differently. Sovereign and corporate bond spreads tend to widen, with larger effects in emerging markets and for weaker credits. Commodity prices can jump when supply is threatened, with oil the classic case. Safe-haven assets such as gold, high-quality government bonds and some reserve currencies often gain, but this is a tendency, not a law.

Effects are not uniform. They depend on the country (own exposure versus spillover from others), its financial and fiscal strength, its trade and energy links, and the sector. Some sectors, such as defence, may benefit while others, such as airlines or firms with exposed supply chains, suffer. Expect exam questions to test this variation, not a single direction.

Key formulas to remember

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.

How to solve Geopolitical Risk and Asset Price Impact questions

Use this order for any question on geopolitical risk and asset prices. It keeps you on the chapter's logic and away from tempting but wrong absolutes.

1Identify the asset class: equity, sovereign or corporate bond, commodity, or currency.
2Identify the shock: a rise in the GPR index, a regional conflict, sanctions or a trade dispute. Note whether it is a country's own risk or a spillover.
3Name the channel: lower expected cash flows, a higher risk premium, or a flight to safety.
4Decide the direction for that asset: equities down with fatter left tail, spreads wider, oil up if supply is at risk, safe havens often up.
5Check heterogeneity: emerging versus advanced economy, fiscal and financial strength, commodity importer versus exporter, sector.
6If numbers are given, compute step by step: new yield = benchmark + spread, then price change ≈ −duration × Δy, then scale by position size.
7Interpret in risk terms: higher VaR or ES, higher stress losses, or a need for tighter limits.
8Eliminate options that use words like always, never or only.

Quickest way: Asset, channel, who, direction

When to use it: Use it for conceptual multiple-choice questions where you have under two minutes.

Underline the asset and whether it is a safe haven.
Ask: cash flows, risk premium or flight to safety?
Ask: whose risk is it, and how strong is that country or sector?
Pick the option with a direction plus a condition. Reject absolutes.
For tail-risk wording, prefer the answer that says downside or left-tail risk rises, not just average returns.

Common mistakes in Geopolitical Risk and Asset Price Impact

Saying all assets fall when geopolitical risk rises.
Students treat geopolitical risk as a generic risk-off shock.
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.
The headline finding is easy to remember without its conditions.
Fix: Always check country strength, own versus spillover risk, trade and energy links, and sector before choosing the direction.
Focusing only on average returns and volatility.
Students link risk to standard deviation by habit.
Fix: Remember the chapter's emphasis on downside tail risk. Think Expected Shortfall and stress tests, because the left tail grows.
Treating safe-haven behaviour as guaranteed.
Textbook examples of gold and Treasuries are over-generalised.
Fix: Use words like tend to or often. A safe haven can fail if the shock hits the safe-haven issuer or if investors sell everything for cash.
Confusing the GPR index with a realised loss or a market price.
An index sounds like a market measure.
Fix: The GPR index is built from news text and measures perceived risk. It is used as an explanatory variable for returns and spreads.
Using the wrong yield change in the duration formula.
Students use the spread move and ignore a falling benchmark yield, or the reverse.
Fix: Compute the new total yield first (benchmark plus spread), subtract the old yield, then apply duration.

Worked examples

Example 1

Which statement is most consistent with the IMF April 2025 GFSR findings on geopolitical risk? A) A rise in geopolitical risk lowers equity returns and increases downside tail risk, with effects varying across countries. B) A rise in geopolitical risk raises equity returns in all countries because of higher risk premia. C) Geopolitical risk affects only commodity prices and has no effect on equities or bonds. D) Geopolitical risk affects all countries and sectors identically.

Show the solution

Identify the asset and direction: equities should fall on average, since the risk premium rises and cash flows are threatened.
Check B: higher premia lower current prices, so higher returns in all countries is wrong and uses an absolute.
Check C: the chapter covers equities, bonds, commodities and currencies, so a commodity-only claim is wrong.
Check D: effects differ by country and sector, so identical effects is wrong.
Check A: it states the direction, the tail-risk point and the variation.

Answer: A

Example 2

An emerging market 10-year USD sovereign bond has a modified duration of 7. Before a regional conflict, the US Treasury benchmark yield is 4.30% and the sovereign spread is 250 bp. After it, the benchmark yield is 4.10% and the spread is 310 bp. Estimate the price change and the loss on a US$50 million position.

Show the solution

Old yield = 4.30% + 2.50% = 6.80%.
New yield = 4.10% + 3.10% = 7.20%.
Change in yield = 7.20% − 6.80% = +0.40%.
Price change ≈ −7 × 0.40% = −2.8%.
Loss ≈ 2.8% × US$50 million = US$1.4 million.
Interpretation: the spread widening (+60 bp) outweighed the flight-to-quality fall in the benchmark yield (−20 bp), so the net effect is a loss.

Answer: The yield rises 40 bp, the price falls about 2.8%, and the loss is about US$1.4 million.

Exam tips

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.
In numeric questions, build the new yield from benchmark plus spread before using duration.
Do not quote specific coefficients or sample figures from the chapter. Questions test direction, channel and interpretation.

Practice questions from Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

Geopolitical Risk and Asset Price Impact in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CFA Level IImpact of Geopolitical Risk on Investments

Geopolitical Risk and Asset Price Impact: frequently asked questions

What are the key findings of IMF GFSR April 2025 Chapter 2?

The chapter studies how rising geopolitical risk affects financial markets and stability. It links higher risk to weaker equity returns, fatter downside tail risk and wider spreads, with effects that differ across countries and sectors. Study the direction, the channels and the variation rather than exact numbers.

How does geopolitical risk affect stock and bond markets?

Equity prices tend to fall as expected cash flows weaken and the risk premium rises. Bond spreads, especially for emerging market and weaker credits, tend to widen. High-quality government bond yields may fall if investors move to safety.

Is gold or the US dollar always a safe haven in geopolitical stress?

No. They often gain, but this is a tendency. The outcome depends on the nature of the shock and on investor behaviour, so avoid answer options that say always.

Why does the FRM link geopolitical risk to tail risk?

Because the chapter highlights that downside outcomes become more likely, not just that average returns fall. A risk manager should therefore look at Expected Shortfall and stress scenarios, not volatility alone.