Geopolitical risk and oil volatility: A new insight

Motivated by the importance of geopolitical risk and its possible predictive power for oil volatility, this paper aims to quantitatively investigate the role of geopolitical risk (GPR), especially serious geopolitical risk (GPRS), in forecasting oil volatility. For research purposes, the GARCH-MIDAS model is extended by incorporating GPR and GPRS. Then, the new extensions are examined from the perspectives of both statistical and economic significance. In-sample results show that GPR and GPRS lead to oil market fluctuations, while the out-of-sample results strongly confirm that the GARCH-MIDAS-GPRS model with serious GPR significantly outperforms the GARCH-MIDAS model. Moreover, both GPR and GPRS help gain higher economic returns. In particular, serious geopolitical risk contains useful information for the recent future oil volatility and can provide the best economic gains. Oil market investors and government policymakers should pay more attention to extreme geopolitical events and serious geopolitical risk in the context of risk management and portfolio allocation. (C) 2019 Elsevier B.V. All rights reserved.