Navigating the Storm: The impact of Geopolitical risk on Sin stock returns

Most of the sin stock literature is focused on examining the performance in stable market conditions, but only few studies are concerning the returns under market downturns or crises. Prior studies find that when markets are under downturns or crises sin stocks tend to generate abnormal returns compared to counterparties, and when markets are in recession sin stocks outperforms the market. The outperformance is even higher under crisis. However, the impact of geopolitical risk on sin stocks has not been studied as the previous studies focus mostly on examining only how certain parts, such as terror attacks, effect stock returns. The purpose of this thesis is to examine the correlation between sin stock returns and geopolitical risk and do sin stocks have hedging capabilities against geopolitical risk. Relationship of these two is studied by constructing an equally-weighted portfolio consisting only sin stocks. The portfolio consists of 13 stocks traded in the United States from alcohol, tobacco, and gambling industries. The daily returns of this constructed portfolio are regressed against geopolitical risk index to capture the reaction of the portfolio to the changes in geopolitical risk. The same is done also for a similarly constructed EGS-portfolio for comparison purposes. The findings of this study shows that sin stocks do not provide a hedge against geopolitical risk and underperforms the ESG-portfolio when the risk increases. The results also suggest that ESG-rated stocks would have some hedging capabilities against geopolitical risk, but the ability is low and insignificant. Moreover, our results show that geopolitical threats seem to have a more greater impact on sin stocks than actual events, whereas stocks in general react to both types of shocks, which is in contradiction with previous literature.