The impact of Israeli Geopolitical Risks on the Lebanese Financial Market: A Destabilizer Multiplier

This paper is the first econometric study that investigates empirically the impact of Israeli Geopolitical Risks on the Lebanese financial market. We run Vector Autoregression model, Granger causality tests, generalized impulse response functions and Variance Decomposition Analysis, to assess the impacts of Israeli Geopolitical Risks (GPRs) on the Lebanese financial stability, on the foreign reserves’ depletion and the economic activity. To measure the Lebanese financial stability, we consider the Lebanese financial stress index that was initially calculated by Ishrakieh et al. (2019, 2020). The geopolitical risks index is measured by taking the continuous variable calculated on a monthly basis to best suit time series analyses, calculated by Dario Caldara & Matteo Iacoviello in 2018. This paper illustrates many novelties such as incorporating the Lebanese financial stress index for the first time in an empirical-econometric study. Also, the adequate level of foreign reserves (also known as international reserves) is taken by calculating the ratio of international reserves to foreign currency deposits as a more appropriate measurement for a dollarized country. Similarly, to measure the economic activity and the business cycle on a monthly basis, we consider the employment in private sector as a better proxy than traditional variables considered in previous studies. Results show that if any financial crisis occurs in Lebanon, an economic recession is more likely to follow within six months. Also, we find that foreign reserves ‘shocks may cause a financial crisis thus economic recession. Finally, we conclude that Israeli GPRs are somehow a destabilizer multiplier: they trigger financial instability and economic recession in Lebanon. They cause international reserves’ depletion, threaten the Lebanese financial market and provoke economic recession. To sustain financial market stability, policy makers should not only accumulate sufficient level of foreign reserves, but also, they have to avoid Israeli-Hezbollah tensions.