Geopolitical Risk and the Performance of European Defence Stocks

Sammanfattning

The European security environment has changed, particularly after Russia’s full-scale invasion of Ukraine in February 2022, which has led to a growing interest in defence-related equities. Rising geopolitical tensions and increased European rearmament have reshaped both policy discussions and investor attention. At the same time, the role of defence stocks in financial markets remains underexplored in a European context, especially in relation to returns, risk and the changing institutional and ESG-related perception within the sector. This study is positioned within traditional financial theory, behavioural finance as well as ESG and new institutionalism, providing theoretical perspectives on how geopolitical uncertainty may affect asset pricing and investor behaviour. Against this background, the relationship between geopolitical risk and the performance of European defence stocks is examined using a quantitative panel design. The analysis covers 11 publicly listed European defence firms with monthly observations from 2011 to 2025. Geopolitical risk is measured using the Geopolitical Risk Index developed by Caldara and Iacoviello, while stock performance is captured through excess returns, logarithmic returns, firm-level volatility, sector-level return dispersion, trading volume and a rolling Sharpe ratio. Fixed-effects panel regressions and complementary time-series models are used to evaluate the relationship between geopolitical risk and stock performance and how this relationship varies across different geopolitical risk conditions. The findings suggest that higher geopolitical risk is positively associated with the performance of European defence stocks, particularly in terms of returns and risk-adjusted performance. The relationship appears conditional rather than constant, becoming stronger during periods of already elevated geopolitical risk and post-2022. Evidence for volatility and trading activity is more mixed. When interpreted through the theoretical framework, the results are consistent with changing expected cash flows and risk premia as predicted by traditional asset pricing theory, as well as with behavioural responses to geopolitical uncertainty. Institutional and ESGrelated shifts provide additional context for the observed patterns.