Geopolitical risk and the dynamics of international capital flows

Using a panel of 45 major economies, we investigate the effects of geopolitical risk on the dynamics of international capital flows. At aggregate level, capital flows for both advanced countries and emerging countries experience significant contractions in the context of increasing geopolitical risk, indicating a flight home effect. Specifically, emerging economies respond to geopolitical risk with a greater magnitude of variations in capital flows. At component level, geopolitical risk generates heterogeneous effect on different components: (i) Other investment for both advanced and emerging countries show significant retrenchment. (ii) Different from the overall condense in capital flows, direct investment shows a flight-to-safety phenomenon, with the direct investment inflows of emerging (advanced) countries significantly decreasing (increasing). Finally, we find short-term predictability of capital flows based on geopolitical risk. Our findings are robust to alternative measures of capital flows, alternative indicators of geopolitical risk, subsample analysis and different data frequencies.