Geopolitical Risk and Cross-Border Portfolio Flows: Effects and Channels

This paper analyses the short- and long-term effects of geopolitical uncertainty on cross-border portfolio flows between the US and 41 developed and emerging economies over the period January 1992-November 2022. We find that geopolitical uncertainty decreases equity inflows from other countries into the US in both the short- and long-term, with this flight home effect generally peaking after 6 months. We investigate the underlying mechanisms and show that the erosion of net financial worth, the evaporation of liquidity and rising risk premia are the key channels through which geopolitical uncertainty affects these inflows, supporting theoretical capital flow models with portfolio choice that feature information and related frictions. By contrast, the responses of other types of flows to geopolitical uncertainty are generally weak and are only found when accounting for the role of some cross-sectional heterogeneity and its time variation.