Beyond Shocks: How ESG Fundamentals Shape Geopolitical Risk Across Countries

This paper examines the connection between Environmental, Social, and Governance (ESG) factors and the risk of geopolitics, as defined by the Geopolitical Risk (GPR) index. The concept of geopolitical risk is conventionally defined as the direct result of political incidents, war, and international tensions. The current study argues that the concept should be understood in a more structural and sustainable manner, relating to the underlying forces driving geopolitical risk. The main research question is whether and how the three pillars of ESG factors contribute to explaining and understanding cross-country and over-time variations in geopolitical risk. In an effort to avoid information loss associated with the ESG index’s aggregate nature, the three factors are considered separately and the three pillars are analyzed individually. The empirical context is a balanced cross-country panel dataset including 42 countries over the 2000–2023 time period. Data for the three factors are obtained from the World Bank dataset to standardize and compare data across countries and over time. The GPR index measures the level of geopolitical risk and is defined by Dario Caldara and Matteo Iacoviello. The GPR index captures the level of geopolitical tensions by analyzing media signals. The combination of the three sources enables direct connections and correlations among the three factors and the internationally recognized GPR index. The paper uses an integrated methodological approach that combines results from three distinct methods. The first method uses panel data analysis to estimate average marginal effects while controlling for unobserved heterogeneity. The second method uses clustering to identify structural patterns and divide countries into groups based on their unique characteristics and risk profiles. The third method uses machine learning regressions and nonparametric analysis to capture the complex relationships and interactions in the data. The three-step method is used for each pillar to ensure consistency and comparability. The results suggest that the three factors contribute to the GPR index in a unique manner. The environment and energy structure contribute to the GPR index as a risk multiplier; the social factor relates to exposure to instability; and the governance factor is a central stabilizing factor. The paper makes a unique contribution to the literature by defining the three factors and their relationship to the GPR index in a clear, sustainable manner.