Why Geopolitical Shocks Threaten Currency Stability

When building a portfolio, investors are advised to diversify as much as possible, reducing the risks from unexpected shocks. This can be achieved through investing in multiple economic sectors, multiple company profiles (small, growing, mature, etc.), and multiple stock types (growth, income, defensive, etc.). But this method still leaves the risks linked to the broader economy of a given country. So most diversification advice recommends also diversifying geographically, investing in different types of economies (developed, emerging, developing) and different regions.

However, international diversification means that such investment is likely done in a different currency from that of the investor’s home country. It can leave investors exposed to geopolitical shocks through currencies, even when the companies they own remain operationally sound.

A new study by Chinese researchers at the Central University of Finance and Economics, the University of International Business and Economics, and the Capital University of Economics and Business is investigating this very question.

They found that geopolitical risk significantly increases the probability of a currency crisis within the next two years. They also found that this effect is stronger under flexible regimes, greater financial development, and higher short-term debt.

They published their findings in International Review of Economics & Finance¹, under the title “The effects of geopolitical risks on currency crises”.

International Exposure Means Geopolitical Risks

In the aftermath of the Soviet Union’s collapse, a period of relative calm in international relations followed, also called the “unipolar moment”, where the influence of the USA and globalization drove fluxes of capital and economic shifts, leading notably to the rise of China as a major industrial and economic center.

However, it is clear that this “moment” is now passing, with a transition to great power competition, with economic and geopolitical blocs like the USA, the EU, Russia, Iran, and China all increasingly in competition with each other, instead of peaceful collaboration.

“Reflecting this heightened risk perception, the Global Risks Report 2025 published by the World Economic Forum identifies state-based armed conflict as the top “immediate” risk, selected by almost one-quarter of respondents.”

This creates an entirely new type of risk for markets and investors that have in large part been able to ignore geopolitical risks for several decades, with the exception of a brief moment during the invasion of Iraq post 9/11.

Source: International Review of Economics & Finance

No longer are currency and military conflict something to just assume “would not happen” between large countries and be confined to peripheral economies, as illustrated by the war in Ukraine or the increasingly destabilized Middle East.

“Unlike purely domestic political disturbances, geopolitical shocks often propagate rapidly across borders through shifts in investor expectations, risk pricing, and cross-border capital allocation, thereby testing the resilience of national monetary and financial systems. ”

Besides outright war or invasion, sanctions, trade wars, tariffs, and other geopolitical risks can also drastically affect the performance of the economy as a whole, as well as the fortunes of specific sectors or companies.

Because such risks can drastically impact the return of stocks in a given country for years, or even decades, it is important for investors with international portfolios to be aware of them and take them into account in their investing strategy.

Geopolitics & Currency Crises

Gathering Data

While previous studies analyzed the effect of geopolitical crises or currency crises on investment returns, there is still a gap in research regarding the connection between the two.

So the researchers created a panel of 41 economies  (19 advanced and 22 emerging) over 1990–2025 and examined whether geopolitical risk predicts currency crisis incidence over the subsequent two-year horizon.

Geopolitical troubles were measured using the Geopolitical Risk Index of fellow researchers Caldara and Iacoviello, constructed by algorithmically scanning articles in ten major international newspapers for references to adverse geopolitical events.

Data were drawn from the World Bank’s World Development Indicators, the IMF’s International Financial Statistics and Balance of Payments Statistics, and the CEIC database. This includes data points such as:

• Cross-border capital inflows and foreign exchange reserves to study transmission channels.
  • Exchange rate regimes were classified from relatively fixed to relatively flexible.
• Foreign exchange reserves: reserves as a share of GDP, the year-over-year growth rate of reserves, and reserves over broad money M2, which gauges the reserve buffer relative to domestic liquidity.
• General economic data: real GDP per capita, inflation, trade openness, real lending rate, the differential between the domestic real lending rate and the U.S. real interest rate, external debt as a share of GDP, and domestic credit to the private sector as a share of GDP.
• Political-economic elements:  central bank independence using the CBI Extended Index and political stability.

Initial Findings

When looking at exchange rates, the researchers found that the effect of geopolitical risk on currency-crisis probability is significantly stronger under relatively flexible exchange rate regimes.

In contrast, greater exchange-rate commitment under relatively fixed regimes (the government stabilizing the exchange rate forcibly) dampens immediate market responses.

Another discovery is that the effect of geopolitical risk increases with the level of financial development. So while greater financial development improves resource allocation, tighter market linkages and more rapid information transmission can propagate geopolitical stress more quickly and more brutally.

This effect is transmitted across foreign-exchange, credit, and equity markets, thereby elevating currency-crisis risk.

Another amplifying mechanism is high debt levels, especially short-term external debt.

“High rollover needs make economies more vulnerable when geopolitical tensions raise precautionary demand or tighten global liquidity, accelerating depreciation pressure and currency crisis onset.”

Regarding foreign exchange reserves, they found that geopolitical shocks reduce reserve accumulation through weaker trade receipts and capital inflows, while central bank interventions to resist depreciation further draw down reserves.

Regional Spillovers

As geographically close countries tend to be more connected economically, a recession or a currency shock in one place is expected to impact its neighbors. This is even more true for geopolitical shocks, as nearby countries could be dragged into a conflict or see their supply chains disrupted.

Overall, the researchers found that cross-border spillovers constitute an important component of the overall relationship between geopolitical risk and currency-crisis probability.

In detail, the study found that spillover/indirect effects of geopolitical crises are almost as impactful as the direct effects, such as a higher domestic currency-crisis probability.

Investing Takeaways

One finding for investors is that greater financial development does not necessarily insulate an economy from geopolitical shocks. More interconnected financial markets can transmit stress quickly, increasing the sensitivity of currencies to geopolitical risk.

Another aggravating risk factor is flexible exchange rate regimes, as geopolitical crises will be tightening external financing conditions and weakening buffers by depressing cross-border capital inflows (direct investment and portfolio investment inflows) and reducing foreign exchange reserve capacity.

Lastly, the importance of spillover effects is significant, and so a crisis in a given country should be assumed to potentially have far-reaching consequences for the region as a whole.

However, the relationship is not automatic. In the study’s sample, 24.9% of country-year observations were followed by a currency crisis within two years. A one-standard-deviation increase in geopolitical risk was associated with a 1.22 percentage-point increase in that probability. These findings support monitoring geopolitical exposure alongside external debt and reserve strength, rather than treating the results as a precise forecast.

Investing In Foreign Currency Risks

Intercontinental Exchange

As geopolitical tensions keep rising all over the globe with great powers struggling to carve spheres of influence, interest in hedging currency risks could rise, especially for more sophisticated investors and financial institutions.

This could greatly benefit companies like Intercontinental Exchange (ICE ), which derive a big part of their revenues from their exchanges, allowing them to trade futures and options covering energy, agriculture, equities, credit, and foreign exchange (FX).

Source: Intercontinental Exchange

In Q2 2026, Intercontinental Exchange generated $1.4B in revenues from its exchanges, out of $2.6B total revenues. The rest of the revenues were generated by fixed income &

data services ($645M), and mortgage technology ($557M).

Overall, the company has displayed very steady growth (15% CAGR in earnings) in the past two decades, benefiting from the trend of financialization, and with recent growth of revenues by 10-12% for most of the company’s products in Q2 2026.

Source: Intercontinental Exchange

In juli 2026, Intercontinental Exchange acquired MarketAxess for $6B, an electronic trading platform for global institutional fixed income markets. The key idea is to cross-sell Intercontinental Exchange’s data and analytics to the more than 2,100 institutional credit clients of MarketAxess, as well as sharing with it the technical infrastructure and corporate support of Intercontinental Exchange.

This stock is more of a “pick-and-shovel” type of investment into financial market infrastructure than a protection against geopolitical risks. And it is not clear if crises will directly impact Intercontinental Exchange’s earnings. But it will likely benefit from higher volatility and uncertainty, as well as its growing economies of scale as it keeps growing either organically or through acquisitions.

Latest Intercontinental Exchange (ICE) News

Study Referenced

^{1. Qingzheng Cao, Jiangshan Liao, and Ruojia Zhu. The effects of geopolitical risks on currency crises. International Review of Economics & Finance. december 2026. Article: 105904. Volume 112. 10.1016/j.iref.2026.105904.}