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

A risk manager at a global asset manager reviews the April 2025 IMF Global Financial Stability Report's discussion of geopolitical risk and portfolio flows. Which pattern is most consistent with the report's findings on how emerging market portfolio flows respond to a rise in geopolitical tensions?

Portfolio flows to emerging markets tend to decline when geopolitical tensions rise, with sharper outflows for countries more exposed to or aligned away from the source of the tension, because investors reassess risk and demand higher compensation rather than chasing yield.

  1. AFlows to emerging markets typically rise as investors seek higher yields
  2. BFlows to emerging markets tend to fall, especially for countries geopolitically distant from or exposed to the source of tensionCorrect
  3. CFlows are unaffected because geopolitical risk is fully diversifiable
  4. DFlows shift only from emerging market equities to emerging market bonds with no net change

Explanation

The chapter's analysis finds that elevated geopolitical risk is associated with weaker portfolio flows to emerging markets, with larger effects for exposed economies. Higher yields do not offset the risk-aversion effect, and the risk is not treated as diversifiable.

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