Assessing the causality relationship between the geopolitical risk index and the agricultural commodity markets

Abstract

Purpose: Geopolitics plays a key role in today’s complex and globalised world. During the last two decades, the world witnessed various geopolitical events, which have led to an increase in geopolitical risk. Consequently, in recent years, there has been renewed interest in both geopolitics and geopolitical risk. In fact, Caldara and Iacoviello’s (2018) seminal work spawned several other works on the topic by clearly defining the notion of geopolitical risk and introducing an index to account for both geopolitical threats and acts. Since the 1970s, the globalisation phenomenon has played a major role in the commodity market. Simultaneously, this phenomenon amplified the scarcity problem, leading to a war on resources, which eventually resulted in increased geopolitical risk. A growing body of literature suggests that geopolitical risk has implications on the commodity market, especially the crude oil industry and the precious metals industry. However, the implications of geopolitical risk on the agricultural industry have received little attention. Therefore, this study investigates the Granger causality between the Geopolitical Risk (GPR) sub-indices to examine the implications of geopolitical risk on 10 agricultural commodities categorised as either softs or grains. Research design and the methodological approach: A quantitative methodological approach was adopted to investigate the Granger causality effects of geopolitical risk on the agricultural future commodity prices. For the purpose of this study, diagnostic tests were conducted to ensure that the data were stationary. In addition, other tests were conducted to ensure that the optimal lag length was selected and to limit the issue of serial correlation in the data. The author computed the Granger causality test to determine the causality relationship between the daily GPR sub-indices and the future prices of 10 essential agricultural commodities for the period from 31st March 2000 to 31st March 2022. Findings: The study identifies that the Threat and Act GPR sub-indices Granger-cause the commodity prices of both wheat and oats. Moreover, these findings can also be related to the ongoing Russo–Ukrainian war, which has definitely impacted agricultural commodity prices since both nations are major agricultural producers. The empirical results also outline how the GPR Threat sub-index Granger causes the soybean oil, coffee, wheat, and oats future prices. On the other hand, the GPR Act sub-index Granger causes the oats future price only. Research implications: It is evidently clear from the empirical findings that the GPR sub-indices impact the agricultural commodity market. Moreover, such findings highlight the predictive power of the GPR sub-indices in relation to changes in future commodity prices, as these contain information that can shed light on the course prices are likely to take following a particular geopolitical event. Originality/value: These empirical results represent a step further towards understanding better the implications of geopolitical risk in the agricultural commodity market. This study should be of value to various economic actors, such as policymakers and national governments, who wish to understand and determine the effects of geopolitical risk and how it may impact national policies. Furthermore, this study can provide an opportunity for businesses and traders to implement risk management in order to limit the effects of geopolitical risk.