Russia-Ukraine: How Much Risk Is Priced In?

“How much is priced in?”

Whenever something bad happens (or looks like it might happen soon), analysts ask that question. Usually, it’s impossible to answer, but stating as much isn’t an option. On any short-term horizon, trading is just gambling, only worse, because with most games of chance, it’s actually possible to quantify the odds. Not so much with geopolitical uncertainty.

“We are asked increasingly how much (Ukraine/Russia) geopolitical risk premium is now priced into a range of global assets,” Goldman’s Dominic Wilson said, in the first sentence of a new note. “It is always difficult to be precise,” he added, gingerly.

Goldman looked at the reaction across assets to recent “sharp shifts” in perceptions of geopolitical risk alongside estimates of risk premium in the ruble in order to gauge the scope of prospective rallies/selloffs in various assets under de-escalation/escalation scenarios.

“Although Russia/Ukraine tensions appeared to affect primarily local assets in January, spillovers to global assets have been much more obvious in February,” Wilson wrote, setting up the table (below).

“In columns one and two we look at two episodes of intensification and relaxation of geopolitical risks and record the performance of key assets across those two events,” Goldman explained. The third column benchmarks the assets to the ruble in order to determine the prospective impact of a “shock” that triggers a 1% move in the currency. Columns four and five show estimates of the “cumulative risk premium” the bank thinks “could plausibly be priced into these assets” or, more simply, “measures of what various assets could do.”

The results are straightforward. There’s considerable downside for stocks in an escalation scenario, and upside on any de-escalation. Describing the “maximum risk” scenario, Goldman said “there could be significant further downside volatility if the crisis escalates fully.”

While the bank cautioned that the exercise “may overstate the magnitude of the asset responses,” they also said that “given a rapidly-evolving geopolitical outlook, YTD correlations may be an imperfect guide to any future market impact from geopolitical tensions, especially if risks around Ukraine are perceived to broaden beyond the region or the commodity impacts broaden.”

The note was penned prior to Putin’s decision to recognize the separatists.