The effects of geopolitical risks on currency crises

Geopolitical risk has become a prominent external shock to macro-financial stability, yet its link to currency crises remains underexplored. Using panel data for 41 economies over 1990–2025, we examine whether geopolitical risk increases the probability of a currency crisis. Probit estimates show that higher geopolitical risk significantly raises crisis likelihood over the subsequent two years, and the result remains robust to alternative specifications. Addressing endogeneity with an IV Probit approach that instruments geopolitical risk using military spending and refugee movements yields consistent evidence. Heterogeneity tests indicate stronger effects under relatively flexible exchange rate regimes, in financially more developed economies, and in countries with higher short-term external debt. Mechanism analyses suggest that geopolitical risk operates by depressing cross-border capital inflows and eroding foreign exchange reserve buffers. Spatial Probit results further reveal significant cross-border spillovers, highlighting the contagion component of geopolitical shocks.