Geopolitical risk trends and crude oil price predictability

Motivated by recent investigations on the connections between geopolitical risk and crude oil prices, we implement a moving average strategy using the geopolitical risk index to identify risk uptrends and thus forecast real crude oil prices. The empirical results show that geopolitical risk trends can significantly predict oil prices both in- and out-of-sample. From an economic perspective, a mean-variance investor can achieve considerable gains using such a simple conversion of geopolitical risk. Moreover, we find that the geopolitical risk trend contains additional information content beyond financial, commodity, and oil fundamentals. The uptrend of geopolitical risk, which disrupts both economic activity and oil production, imposes stronger shocks on future oil demand than on supply, and thus results in a dramatic decrease in oil prices.