Geopolitical threats and the reversal of equity size premiums

Abstract

<p>We examine how geopolitical threats affect U.S. equity portfolios across market capitalizations using daily returns from 1995 to 2024. Large and prime-cap portfolios generate significantly positive returns during heightened geopolitical tensions and yield 0.52% risk-adjusted excess returns during high-threat periods. Small and mid-cap portfolios show no response. Markov regime-switching analysis reveals that this effect intensifies eightfold during high-volatility states. Geopolitical threats represent unique uncertainty distinct from market volatility or economic policy uncertainty. Effects occur contemporaneously with no lagged adjustment and indicate rapid information processing. Results remain robust across alternative specifications and out-of-sample tests. Implementable trading strategies that capitalize on these differential responses can generate substantial economic value. Our findings extend safe haven asset literature to intra-asset class dynamics and demonstrate how firm size moderates geopolitical risk responses with direct implications for strategic asset allocation during global uncertainty.<br></p>