Energy 187 (2019) 116003

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Energy
journal homepage: www.elsevier.com/locate/energy

Does geopolitical risk strengthen or depress oil prices and financial

liquidity? Evidence from Saudi Arabia
Chi-Wei Su a, Khalid Khan b, *, Ran Tao c, Moldovan Nicoleta-Claudia d
a
School of Economics, Qingdao University, China
b
School of Finance, Qilu University of Technology, China
c
Qingdao Municipal Center for Disease Control & Preventation, China
d
Department of Finance, West University of Timisoara, Romania

a r t i c l e i n f o a b s t r a c t

Article history: The present study assesses the causality of geopolitical risk (GPR), oil prices (OPs) and financial liquidity
Received 7 February 2019 by means of wavelet analysis, which aims to investigate whether such relationships support the mon-
Received in revised form etary equilibrium model in Saudi Arabia. Our findings indicate that OP and financial liquidity are related
11 July 2019
in the time domain when GPR is high. We detect both short- and medium-term correlations among OPs,
Accepted 22 August 2019
Available online 27 August 2019
financial liquidity and GPR in the frequency domain. Additionally, in the absence of GPR, we notice a mid-
term correlation between OPs and financial liquidity in the time and frequency domains. Our results
support the assumed monetary equilibrium model, which, in turn, is an indication of the fact that OPs are
JEL classification:
G15
dependent on GPR and that financial liquidity relies on the OP. Such conclusions suggest that the country
F31 would benefit from adopting a resource income diversification policy to reduce its impact on OP fluc-
G33 tuations. Additionally, the diversion of unnecessary government expenditures to the investment pro-
grams would also represent a beneficial shift in action.
Keywords: © 2019 Elsevier Ltd. All rights reserved.
Geopolitical risk
Financial liquidity
Oil prices
Wavelet analysis

1. Introduction
The debate related to geopolitical risk (GPR) and oil prices (OPs)
has become increasingly important due to trade integration and
globalization [59]. Rising OPs are an indication of affluent econo-
mies and abundant financial liquidity for oil exporting countries.
More specifically, increasing OPs can be a signal of increasing in-
come, which can lead to consumption, investment, productivity
and financial liquidity [20]. Nevertheless, this higher OP may
constitute increased production and transportation costs for oil
importing countries, thus generating inflationary pressure on the
interest rate and lower financial liquidity [19]. However, OPs are
considerably more susceptible to geopolitical events and a major
GPR shock can potentially trigger strong impacts on both OPs and
financial liquidity through the tightening of the monetary policy
[2]. Moreover, GPR has a significant impact on market sentiments in
* Corresponding author. No.3501, Daxue Road, Changqing District, Jinan, 250353,
Shandong, China.
E-mail address: Shah_khan884@yahoo.com (K. Khan).
the oil market, investor behavior and decision-making, which are
ultimately reflected in the OPs [36e52]. Likewise, financial liquidity
stimulates the prices due to aggregate demand, which, in turn,
leads to increased commodity prices, including OPs. Unanticipated
geopolitical events may significantly affect oil production and
aggregate demand, which is ultimately reflected in the OPs and
financial liquidity [51e62]. Thus, the OPs' sensitivity towards GPR
and their ultimate consequences for the financial liquidity of both
exporting and importing countries remains one of the challenges.
The effect of global political uncertainty on OPs and the funda-
mental macroeconomic variables requires more attention. This
paper highlights the effects of GPR on the relationship between OPs
and financial liquidity in Saudi Arabia, which is the biggest econ-
omy in the Middle East [13], and the largest oil exporter and an
acknowledged powerful member of the Organization of Petroleum
Exporting Countries (OPEC) [15]. Its government expenditures re-
lies on oil revenues, which were used in diverse projects to achieve
economic growth and stability [13]. However, given its massive
dependency on OPs, the country is vulnerable to economic and
political events [33]. The world observed the effects of GPR in

https://doi.org/10.1016/j.energy.2019.116003
0360-5442/© 2019 Elsevier Ltd. All rights reserved.
2 C.-W. Su et al. / Energy 187 (2019) 116003
2001e2003 and Saudi Arabia when compensated for the missing
Iraqi oil supply by increasing their supply to the point of reaching a
20% share of the oil market. This precarious situation was followed
by a period of stability that was globally characterized by low GPR,
resulting in increased demand for oil and ample revenues [73].
During the period, the government spending, consumption and
provision of credit to the private sector increased due to oil reve-
nues. Even though OPs significantly declined in 2008e2009 due to
the global financial crisis, their influence was safeguarded by
employing the abundant revenues that were acquired during the
previous prosperous period. Similarly, OPs declined during
2011e2012 as a result of the low demand that resulted from the
Eurozone debt crisis and the fear of supply disruption due to the
instability among OPEC countries. There has been discontent in the
public and government sectors, which led to the necessity to spend
large amounts of funds on social welfare and subsidies to control
the problems that resulted from the rise in financial liquidity.
Likewise, OPs were volatile from 2014 to 2016 and reached a 13 year
low due to the uncertainty of the key producers, slowing economic
growth and changes in OPEC's policies [22]. Additionally, U.S.
sanctions on Iran, which may curtail oil exports, have generated
additional uncertainty. According to the Saudi Arabian Monetary
Authority (SAMA), financial liquidity has slightly increased
compared to the previous year due to government expenses that
were employed to curb the resulting economic frustration.
The study has the following objectives. First, the study seeks to
provide a better understanding of GPR's effects on OPs. When the
nonoil shares of GDP are significantly low compared to oil shares,
which are dependent on the economic and political factors, they
pose serious challenges for the fiscal and economic management in
the long run [13]. Second, we highlight the impacts of GPR on OPs
and their repercussions for financial liquidity. Government
spending is the channel that impacts financial liquidity and is
vulnerable to the external shocks emanating from GPR. Similarly,
the previous oil crises of 1973 and 1979 were linked to instability in
the Middle East, which means that Saudi Arabia, being the most
important country of the region, is equally significantly sensitive
towards GPR [50]. Third, the study examines the relationships be-
tween GPR, financial liquidity and OPs in the time and frequency
domains. The study will determine whether the relationships be-
tween these variables change in the short term or long run and
which ones are leading or lagging due to different geopolitical
events. Last, we examine whether OP fluctuations are the biggest
risk for Saudi Arabia. As one of the major oil producers, any political
event or war in the region can affect the oil supply and lead to
detrimental effects for the oil market [32]. There is a high potential
for OPs to influence the world economy and fiscal and economic
development and therefore its fluctuations are among the main
risks and challenges for the country.
The prior literature is missing studies on the correlation be-
tween OPs and financial liquidity in the presence of GPR, and vice
versa, across the time and frequency domains. Therefore, the cur-
rent study fills this gap and analyzes the correlation among GPR,
financial liquidity and OPs in the time and frequency domains. GPR
is used as the control variable to determine whether its presence
and absence have any effect on the correlation between OPs and
financial liquidity. The results confirm that in the presence of GPR,
OPs have short term impacts on financial liquidity, thereby sug-
gesting that when high GPR exists, OPs have a positive impact on
financial liquidity. Similarly, OPs have a positive impact on financial
liquidity in the midterm in the absence of GPR. The findings are
consistent with the monetary equilibrium model, which states that
OPs are sensitive to GPR and ultimately affect domestic financial
liquidity. Therefore, the country should adopt a policy of diversifi-
cation of income resources to minimize the effects of OPs.
This article adds to the literature in two ways. First, we inves-
tigate the importance of GPR in OP changes and their ultimate
impacts on financial liquidity and demonstrate the evolution of the
association between the variables with respect to the time and
frequency domains. This is the first study to examine whether GPR
may affect OPs and financial liquidity in Saudi Arabia. The results
explore the short-term impact between OPs and financial liquidity,
as well as the significant effects of GPR on both OPs and financial
liquidity in the short term. Second, the present knowledge is
enriched due to the different method that is employed e the
wavelet method e which can explore both the time and frequency-
varying performance of the association, compared to traditional
time series approaches that cannot detect both [66]. Hence, by
these means, it is possible to analyze the relationships at different
periods and potential structural changes.
The remainder of this paper is structured in the following
manner. Section 2 reviews the literature, and section 3 explains the
theoretical analysis. These sections are followed by section 4, which
defines the methodology, and section 5, which describes the data.
Next, section 6 presents the results. Section 7 provides discussion
and policy implications, and section 8 outlines the conclusion.
2. Literature review
Several studies have assessed the association between GPR and
OPs. Humphreys [41] evaluates whether natural resources affect
the relationship and the findings assert that geopolitical uncer-
tainty is linked to natural resources. Leder and Shapiro [53]
conclude that oil resources may cause GPR in the form of military
conflicts. Kesicki [49] notes different geopolitical events are
responsible for the recent OP fluctuations. Kollias et al. [51] report a
positive impact of terrorism on Ops and highlights that violence can
increase OPs. Cotet and Tusi [30] estimate that abundant oil re-
sources increase the possibility of GPR. Bazzi and Blattman [24]
show that OP fluctuations have very weak impacts on GPR. Caselli
et al. [28] reveal that regional conflicts emerge due to oil resources.
Chen et al. [29] show that GPR has a significant positive impact on
OPs. Noguera-Santaella [58] inspects the nexus between armed
conflicts and OPs and concludes that there is a positive impact from
geopolitical threats. Bariviera [23] assess the changes in informa-
tional efficiency from major geopolitical actions and conclude that
OPs are correlated with geopolitical events. Ji et al. [44] evaluate
exchange rate risk's impact on OPs and conclude that there is a
dynamic and positive relationship between the RMB and OPs while
there is a negative relationship between the U.S. dollar and OPs.
Zhang et al. [74] analyze the spillover effects in the global oil market
by assessing the seven main crude OPs. The results show that most
of the crude OPs are more volatile due to GPR, and they increase the
integration level between the regional oil markets. Ji et al. [42]
report that the most volatile OPs exist in the presence of political
and economic events that make the market sentiments fragile.
However, some of the previous studies have investigated the
effect of GPR on financial liquidity. El-Gamal and Jaffe [35] find that
both GPR and financial liquidity increase OPs. Blomberg et al. [25]
report that decreasing market power has decreased the effect of the
GPR premium on OPs. Al-Roubaie [16] shows that increasing OPs
create an imbalance in international liquidity and decrease trade.
Ratti and Vespignani [62] evaluate the effects of liquidity on OPs for
Brazil, Russia, India, and China (BRIC) countries and the results find
that financial liquidity increases OPs. Uddin et al. [72] evaluate the
GPR and OP nexus and find a high degree of coherency between the
two variables. Abdel-Latif and El-Gamal [2] show that low OPs
generate higher GPR and decrease financial liquidity. Ji et al. [45]
measure energy prices’ dependency on economic and financial
uncertainties. The results show that there is a negative impact of
 C.-W. Su et al. / Energy 187 (2019) 116003
uncertainties on energy prices and vice versa. Meanwhile, some
other studies highlighted the effects of OPs on financial liquidity.
Qianqian [60] reports that OPs negatively influence monetary
policy in the long term. Antonakakis et al. [19] detect that GPR
negatively influences oil returns. Jo [47] examines the effects of OPs
on the economy and concludes that there is a negative impact of
OPs on financial activities. Cunado et al. [31] explore how oil
returns decline because of the weaker oil demand that is caused by
GPR. Caldara and Iacoviello [27] explore how the increase in GPR
decreases OPs. Ji et al. [43] estimate the oil import security that is
required for sustainable economic development and show that the
GPRs in oil-exporting countries are the major concern for OP
volatility. Abderrezak [3] questions the presence of a nexus be-
tween OPs and financial liquidity and finds no relationship between
the two variables. Martina et al. [56] highlight the effect of GPR on
OPs and find no connection between the two variables.
Dadwal [32] argues that political instability has serious re-
percussions for OPs in Saudi Arabia. Abdulkheir [4] suggests that
OPs and financial liquidity have a long run relationship. Naifer and
Duhaiman [57] suggest that OPs have important effects on mac-
roeconomic variables. Alsamara et al. [17] find a long-term impact
of OPs on financial liquidity. Lee [56] finds a positive relationship
between OPs and uncertainty. Aloui et al. [15] evaluate the link
between global risk factors and OPs and the results show that such
risk strongly and negatively influences OPs. Rizvi and Masih [63]
find no impact of OPs on financial liquidity.
We summarize the previous literature in the following ways.
First, most of the studies have focused on the relationship between
GPR and OPs, and none of the prior papers has analyzed the impact
of GPR on the nexus between OPs and financial liquidity. The works
of Bazzi and Blattman [24], Chen et al. [30], Abdel-Latif and El-
Gamal [2], Uddin et al. [72], Cunado et al. [31] and Caldara and
Iacoviello [27] have evaluated the relationship between GPR and its
impact on OPs. The results indicate that GPR is the leading factor in
OP fluctuations. However, there is a further division regarding
geopolitical risk and some of the studies have used terrorism as a
major source of political uncertainty in different countries. The
studies of Dadwal [32], Kesicki [49], Kollias et al. [51], Cotet and Tusi
[30] and Noguera-Santaella [58] have highlighted the impact of
terrorism on OPs. However, terrorism can be a regional phenome-
non and may not have a far-reaching impact on OPs. Second, the
previous literature has investigated the one-sided impact of GPR on
OPs while missing the impact of OPs on GPR. Oil is one of the
strategic resources in the modern economy and can be a reason for
GPR in different parts of the world. There is a dearth of studies that
explored the impacts of OPs on GPR. Third, the majority of the
studies that have investigated the relationship between GPR and
OPs have used traditional estimation methods. The works of
Abderrezak [3]; Al-Roubaie (2010); Noguera-Santaella [58], Ratti
and Vespignani [62]; Chen et al. [29]; Alsamara et al. [17]; Anto-
nakakis et al. [19] and Caldara and Iacoviello [27] have employed
conventional procedures to explore the relationships. They have
used generalized autoregressive conditional heteroskedasticity
(GARCH), autoregressive distributed lag models (ARDL), autore-
gressive distributed lag vector autoregression (VAR), the vector
error correction model (VECM) and ordinary least squares (OLS).
Such methods have disadvantages related to the model description,
the number of lags and spurious regression results. Likewise, while
conventional approaches used the full sample to assess the asso-
ciation between GPR and OPs, time-varying characteristics cannot
be detected due to the low power size, which makes it not suitable
for assessing the lead-lag relationship across various frequencies
[75]. Furthermore, traditional procedures do not provide an inte-
grated basis to evaluate time and frequency changes. Last, the
conventional Granger causality cannot be used to explore the
3
causal links across the time domain [38].
3. Monetary equilibrium model
Similar to Abdallah et al. [1], we use the monetary equilibrium
model to describe the mutual relationship among OPs, financial
liquidity and GPR. The model has been used to explain the trans-
mission mechanism through which an increase in OPs affects the
money market equilibrium in oil exporting countries [1e3] Most oil
exporting states are developing countries that are seriously
dependent on oil revenues. Therefore, we suppose an open econ-
omy with a fixed exchange rate system that is heavily dependent on
oil exports. Increasing OPs results in added income that could be
the main determinant of the money supply and vice versa [15].
According to Fisher's (1911) equation, money is a function of
income.
M ¼ k  PY (1)
where k is the money multiplier, M is the money supply, P is the
price level and Y is the real output. Increased OPs in the fixed ex-
change rate system may increase liquidity through total foreign
assets and credit to government, and vice versa.
DMS ¼ DTFC þ DTCG þ DTCE (2)
where DTFC represents the change in the total foreign reserves,
DTCG represents the change in the total credit to the government
and DTCE is the change in the total credit to the economy. It is
argued that increases in OPs may have positive impacts on a
country's income and the production of service and goods [46].
Stable OPs will be reflected in increasing exports, aggregate gov-
ernment expenditures and foreign reserves. This growth trend in
aggregate expenditures results in a higher domestic money supply,
which will further increase consumption, spending and wealth. The
output equation is as follows:
Y ¼ f ðOP; EXP; FR; GEX; GPRÞ (3)
where EXP denotes exports, FR is the foreign reserves and GEX is
government expenditures. Similarly, OPs are causal factors of the
money supply, government expenditure, consumption and wealth.
They can be estimated as follows:
OP ¼ f ðY; GEX; MS; FR; EXP; GPRÞ (4)
However, OPs are characterized by high instability and are
sensitive to uncertainties in the short term. Particularly, GPR might
affect the oil supply, and the effects of the supply disruption on OPs
might be the cause of lower incomes, which influences financial
liquidity [21]. Several studies have assessed the transmission
mechanism from GPR to OPs, which is eventually reflected in
financial liquidity [2e25]. The high GPR affects the OPs and reduces
financial liquidity [58]. Equally, financial liquidity is the function of
the real output and OPs. The higher OPs are expected to affect the
output due to their positive influence on net exports and possibly a
higher price level [39]; therefore, the money supply will increase,
and vice versa.
MS ¼ f ðOP; GEX; GPRÞ (5)
We conclude that OPs are the main factor affecting the money
supply, government expenditures, and GPR. However, OPs were
linked to GPR, which is ultimately connected in the same way to
domestic financial liquidity. The model describes the GPR and its
impact on the OPs in oil exporting countries with fixed exchange
rate regimes. Such countries are heavily dependent on oil revenues
4 C.-W. Su et al. / Energy 187 (2019) 116003

for their government expenditures and fiscal policies. OP instability 4.3. Wavelet coherency and phase difference
can severely dampen financial liquidity at the domestic level. Our
empirical results confirm that GPR is the main contributing factor The cross-wavelet and autowavelet power spectrum are utilized
in OP formation, which is transmitted to financial liquidity. to estimate the wavelet coherency [71], and it is calculated as
Furthermore, OPs have short-term roles in financial liquidity when follows:
facing increasing GPR and vice versa.
  1 
S k WAB ðk; rÞ 2
R2xy ðk; rÞ ¼   (9)
4. Wavelet analysis methods S k1 jWA ðk; rÞj2 S k1 jWB ðk; rÞj2

The wavelet approach has replaced the Fourier transform where S represents the continuous driver. The wavelet coherency
technique and offers an improvement by considering the causality R2AB ðk; rÞ2½0; 1 is computed on the time and frequency scales and
relationship in both the time and frequency domain aspects [2008]. shows no association if the coherency is zero. The direction and
This method instinctively anticipates both time and frequency strength of the time series are determined by the phase difference.
variations in a definite window. Similarly, this method detects the The phase difference between AðtÞ and BðtÞ is explained [26] as
co-movements and causal link over the same points of time. follows:
Compared to conventional methods, wavelet analysis does not
  !
need to pretest the stationarity and lag length. It is favorable and
1 I S k1 WAB ðk; rÞ
extremely suitable for nonstationary series [65]. There is no prior jAB ¼ tan   ; withjAB 2½p; p (10)
R S k1 WAB ðk; rÞ
requirement to conduct traditional tests of the stationarity and lag
determination. Wavelet analysis has been used in several studies
where I denotes the theoretical portion and R is the real portion of
like Aguiar-Conraria & Soares [5e9]; Rua [66e68]; Rua & Nunes
the continuous cross-wavelet transform. The process of elimination
[69], to examine the wavelet coherency across the time and fre-
of CðtÞ determines the association between AðtÞ and BðtÞ; which is
quency domains. Thus, this study uses wavelet analysis to evaluate
termed the squared partial wavelet coherency [7], and it is
the correlation among GPR, financial liquidity and OPs. Appendix A
formulated as follows:
provides more detail explanation for the wavelet analysis and help
in understanding step by step procedure.  
RAB ðk; rÞ  RAC ðk; rÞR* ðk; rÞ2
R2ABjC ðk; rÞ ¼  BC
(11)
1  ðRAB ðk; rÞÞ2 1  ðRBC ðk; rÞÞ2
4.1. Continuous wavelet transforms

The procedure of decomposing and superimposing information where RAC ðk; rÞ and RBC ðk; rÞ denote the coherencies between AðtÞ
that is derived from the transformation process is the foundation of and CðtÞ and between BðtÞ and CðtÞ, respectively. The partial phase
wavelet analysis. The continuous wavelet transforms (CWTs) are difference is estimated as follows:
applied to time series to achieve data similarity and divide them  
IfHABjC ðk; rÞg
into wavelets [37e55]. It is derived from the mother wavelet J ðtÞ jABjC ¼ tan1 (12)
as follows: RfHABjC ðk; rÞg
  This article evaluates the relationship among OPs, financial
1 tk
Jr;K ðtÞ ¼ pffiffiffi J (6) liquidity and GPR. The connection between them is estimated
k k
among the three series in three different ways. First, the lead-lag
where k is the wavelet scale, and r is the location of a parameter. relationship is estimated between OPs and financial liquidity. Sec-
Therefore, the CWT of a time series xðtÞ is defined as follows: ond, the relationships between GPR and OPs and between GPR and
financial liquidity are respectively estimated. Third, the partial co-
ð
þ∞ herency is used to assess the impacts of GPR on the causality be-
* tween OPs and financial liquidity.
WA ðr; kÞ ¼ AðtÞbr;k ðtÞdt (7)
∞
5. Data
where b*r;k denotes the complex conjugate. The magnitude of "CðtÞ"
is estimated for both the time and frequency scales if both k and r We used the monthly observations ranging from 1998:01 to
change [70]. 2018:07 to detect the co-movements among OPs, financial liquidity
and GPR in Saudi Arabia. OPs reached their lows during 1998 due to
4.2. Wavelet power spectrum the Asian financial crisis that resulted in the slowest economic
growth. This decreased foreign reserves and increased budget
Wavelet power spectrum is utilized to estimate time and fre- deficit and financial liquidity problems. The low OPs led to OPEC
quency changes at all scales of the series and is represented as curtailing oil production, which was reflected in the increasing OPs.
jWC ðr; kÞj2 . It measures the local variance of the two-time series In addition, economic reforms and major restructuring processes
AðtÞ and BðtÞ across the time and frequencies. Similarly, Hudgins were initiated [61]. In Saudi Arabia, oil income constitutes 80% of
et al. [40] adjusted the cross-wavelet transforms, which can be the government's revenues and 45% of GDP [15]. As one of the
described as follows: prominent members of OPEC and one of the largest oil exporters,
Saudi Arabia's potential to influence and affect the uncertainty in
 2
jWAB ðr; kÞj2 ¼ jWA ðr; kÞj2 W *B ðr; kÞ (8) the global economy has increased. OPs were the most vulnerable
during the 2008 global financial crisis and the Arab Spring. The
The colored lines on the right-hand side indicate the wavelet current low OPs have a strong impact on government spending and
power. The red represents higher power and blue represents lower the government has resorted to using foreign assets to cover the
power. budget deficit. The volatility that is caused by the GPR may have
 C.-W. Su et al. / Energy 187 (2019) 116003
serious ramifications for OPs, which eventually affect the public
sector. This may be more important because Saudi Arabia has
abundant stockpiled foreign reserves in the last decade due to the
high OPs, and the uncertainty will negatively affect it. Therefore,
the OP risk is one of the biggest challenges surrounding the
geopolitical situation.
The financial liquidity is expressed in term of the M2 Money
Supply using data that were retrieved from the Federal Reserve
economic data (FRED). The government expenditures are the fiscal
and monetary instruments that are derived from the oil export
revenues, which have a substantial impact on the M2 money supply
in Saudi Arabia [12]. The rising OPs may increase the money supply,
which is one of the channels through which OP shocks can influ-
ence economic activity [17]. The country is pursuing a monetary
policy with a fixed exchange rate regime that implements some
restrictions on capital and has a massive dependency on foreign
reserves [48]. Monetary policy is the tool that is used to maintain
price stability when the depletion of the foreign reserves may
endanger the financial liquidity [18]. OPs are measured using the
spot prices of West Texas Intermediate (WTI), which are collected
from the Global Financial database [62]. GPR is related to wars,
terrorist attacks, and tension between states that can influence the
usual routines of national politics and international relations [27].
We have transformed all the data into their natural logarithmic
forms to avoid the heteroskedasticity problem. Our data contain
several ups and downs during the study period displayed by Fig. 1.
The most important time period is 2001e2003 when GPR and OPs
started to rise. However, the GPR remained at the lowest level from
2004 to 2008 and OPs reached their highest. Similarly, there was
high uncertainty from 2008 to 2009 due to the global financial
crisis that resulted in decreasing OPs while financial liquidity
remained intact. GPR increased while OPs declined from 2013 to
2014.
As almost all the previous oil shocks are caused by the uncer-
tainty in the Middle East, which has spillover effects for the largest
oil producer Saudi Arabia. Therefore, the regional political dy-
namics have always been an important determinant of OPs for
Saudi Arabia. Regional countries such as the United Arab Emirates,
Qatar, Iraq and Iran are important members of OPEC and play sig-
nificant roles in the formation of OPs. This regional integration has
contributed to the GPR of Saudi Arabia in different time periods.
From 2001 to 2003, the region had a higher level of political un-
certainty that was caused by the 9/11 terrorist attacks in 2001 and
the following by the Iraq war. Both conflicts were connected with
the Middle East, which includes the largest oil exporters, and the
Fig. 1. The trends of GPR, OP and M2.
5
political unrest might disrupt the oil supply. Especially, in the case
of the Iraq war in 2003, it was predicted that the oil market would
be deprived of the Iraqi oil supply, which would affect OPs. How-
ever, Saudi Arabia improved the situation by increasing the oil
supply and became one of the largest suppliers. The country pro-
vided very large oil revenues that helped to stabilize financial
liquidity. Meanwhile, the boom period from 2003 to 2008 is
distinguished by low GPR and rising Ops, which resulted in robust
economic growth and higher financial liquidity [73]. However, the
financial crisis in 2008 decreased OPs due to the low oil demand.
The severity of the crisis was mitigated by using the abundant re-
serves that aided government expenditures, which are the main
source of domestic liquidity. Similarly, the Arab spring had no se-
vere impact on Saudi Arabia, and a high level of political uncer-
tainty at the regional level caused the country to change its
strategic environment [10]. The rising social discontent was ex-
pected due to the political turbulence in the regional countries and
proactive measures were taken to curb the discontent in the form of
increasing subsidies and more employment opportunities. Like-
wise, severe OP fluctuations that were detected from 2014 to 2017
were mainly caused by the strained situation between Saudi Arabia
and its neighboring countries, which can have a significant effect on
OPs. Last, the expected U.S. sanctions on Iran could restrict oil ex-
ports and can change the regional political situation. Low prices
have affected the liquidity and the government has to resort to
using foreign reserves to mitigate the severity of low OPs. Likewise,
the price settlement problem between OPEC and the U.S. can affect
oil production. As the largest producer of the oil and a significant
link with the world economy, Saudi Arabia is sensitive to political
and economic crises that result from GPR, and this provides a sound
foundation for this study.
6. Empirical results
Table 1 illustrates the descriptive statistics of GPR, OP, and M2.
The mean values are 4.603, 3.903 and 12.037, respectively. All the
three variables are negatively skewed; thus, the series are skewed
to the left. The kurtoses of OP and financial liquidity are less than 3,
thereby suggesting platykurtic distributions. Meanwhile, the GPR is
determined to follow a leptokurtic distribution because the kurtosis
is more than 3. All three variables are nonnormally distributed, as
specified by the Jarque Bera test.
Fig. 2 illustrates the findings related to the association between
OP and M2. It is determined that in the period from 2002 to 2003,
OP positively lead M2 positively with the phase difference in the
6 C.-W. Su et al. / Energy 187 (2019) 116003

Table 1
Descriptive statistics of GPR, OP and M2.

Variables Mean Maximum Minimum Std. Dev. Skewness Kurtosis Jarque Bera

GPR 4.603 5.292 3.613 0.305 0.501 3.330 11.495***

OP 3.903 4.896 2.242 0.581 0.521 2.417 14.680***
M2 12.037 12.993 10.964 0.713 0.085 1.509 23.153***

Note: GPR, OP, and M2 denote geopolitical risk, oil prices, and financial liquidity respectively. *** represents the significant level at 0.01 level.

Fig. 2. The wavelet coherency and the phase difference between OPs and M2. Notes: The y-axis refers to the frequencies (measured in months); the x-axis refers to the time period
1998:01e2018: 08. the y-axis refers to the frequencies (measured in years); The color bar on the right side corresponds to the strength of the correlation at each frequency. The black
contour shows the 5% significance level which is obtained by Monte- Carlo-simulations with 1000 replications. . (For interpretation of the references to color in this figure legend,
the reader is referred to the Web version of this article.)

range of ½0; p=2, an average coherency of 0.6 and a frequency of 2e4
years. The higher coherency reflects the short-term causality
running from OP to M2, and the findings are similar to the work of
Alsamara [17], which explores the positive impact of OP on financial
liquidity in Saudi Arabia. Over the period, the OP resulted in higher
revenues and increased government spending [14]. The main de-
terminants could be the political instability that was caused by the
U.S. invasion of Iraq, which led to a high level of uncertainty
regarding the oil supply. This gap between the oil demand and
supply was covered by Saudi Arabia and this made the country the
largest oil supplier. The revenues increased, which, in turn, boosted
financial liquidity through government expenditures for public
welfare. We observe the comovement between OP and M2 from
2004 to 2007, which was marked by high economic growth and
increased demand for oil. Over the same period, OP reached its
highest level of 147 dollars per barrel and Saudi Arabia was one of
the beneficiaries of the increased OP. These plentiful oil revenues
were transmitted to domestic level liquidity through government
expenditures. From 2008 to 2009, M2 was leading OP ð½ p=2; 0Þ
with an average coherency of 0.8 and a frequency of 1e2 years,
which suggests that M2 has an important role in the OP [62]. Ac-
cording to the SAMA, M2 increased compared to the previous year
due to experiencing the highest OP since 2008. However, the OP
decreased due to the low demand that resulted from the 2008
financial crisis, which may have led to the decline of oil revenues.
The government converted their abundant foreign reserves that
were gained during the boom period into expenditures, which
ensured the stability of their liquidity position. The accommodative
monetary policy, which was adopted by the SAMA, is aimed at
achieving financial stability and enhancing the liquidity positions of
banks in order to facilitate credit to the private sector. Similarly,
time and savings deposits and foreign currency accounts increased,
which contributed to the country's liquidity position [11].
Fig. 3 displays the results for the causality and co-movement
between GPR and OP. It shows that from 2000 to 2002, GPR is
positively leading OP in the short term with an average coherency
of 0.6- and a frequency of 2-4-years.1 This is in line with the study of
Noguera-Santaella [58], which shows that GPR has a positive
impact on OP. The terrorist attacks in the U.S. were the main factor
1
The wavelet analysis shows that during the period of the higher GPR, the OP is
leading financial liquidity in the short run. The oil marker can have short term
fluctuations that increase OPs, thereby providing substantial revenues that ulti-
mately positively impact financial liquidity. The wavelet analysis is basically a
graphical representation of the correlation between GPR and OP, and so it is
demonstrated in the figure.
 C.-W. Su et al. / Energy 187 (2019) 116003 7

Fig. 3. The wavelet coherency and the phase difference between GPR and OPs. Notes: The y-axis refers to the frequencies (measured in months); the x-axis refers to the time period
1998:01e2018: 08. the y-axis refers to the frequencies (measured in years); The color bar on the right side corresponds to the strength of the correlation at each frequency. The black
contour shows the 5% significance level which is obtained by Monte- Carlo-simulations with 1000 replications. . (For interpretation of the references to color in this figure legend,
the reader is referred to the Web version of this article.)

since most of the perpetrators were identified as Saudi Arabia cit-
izens, which raised concerns about the stability of the regime. A
regime change was expected, which might harm OPs because Saudi
Arabia is the swing oil producer and any disturbance may influence
OPs. It has decisive power in the setting of OPs due to its undeniable
position in the international oil market [32]. Likewise, we notice
the relationship between GPR and OP approximately 2018 in the
short term. The GPR is rising for several OPEC members, especially
Saudi Arabia, which is facing Yemen's Houthis war. This war in-
cludes both Saudi Arabia and Iran who are involved in a proxy
struggle for the regional supremacy. Similarly, Iran has problems
with the U.S. The U.S. pulled out of the nuclear deal in May 2018 and
imposed sanctions on Iran's oil exports, both of which have
impacted the oil market. In addition, the failure of the negotiations
between the U.S. and North Korea may halt the flow of oil to South
Korea, China and Japan, which account for 34% of the global oil
trade. All these factors, as well as Saudi Arabia, have reduced pro-
duction per day and demand to where the price is 88 dollars per
barrel.
The results of the relationship between GPR and financial
liquidity are illustrated in Fig. 4. The finding suggests that from
1999 to 2002, GPR caused M2, and the phase difference is in the
range ½0; p=2, which means that GPR has a positive impact on M2
with an average coherency of 1e2 and a frequency of 0.6 years. It is
recommended that the level of financial liquidity increases in line
with the level of GPR changes [2]. Prior to 9/11, the region was
facing uncertainty due to the regime change in the U.S. The new
government perceived Middle Eastern countries as rogue states
and showed aggression. The GPR has remained high to some extent,
resulting in higher oil revenues that are ultimately reflected in the
increase in government expenditures and domestic liquidity in the
form of credit to private banks [34]. GPR is positively leading M2
from 2010 to 2012 with an average coherency of 0.6 and a fre-
quency of 1e2 years. During the period, the GPR increased mainly
due to the Arab Spring, as well as the Syrian and Lybian wars. The
Arab Spring was the result of the despair of the masses due to
unemployment, corruption, and dictatorships in Middle Eastern
countries. The contagious effect of the disorder has led to an in-
crease in the uncertainty that could affect the oil supply and will
impact global oil production. This makes Saudi Arabia become
worried about the expected unrest in the country, and the country
has tried to alleviate the conditions by spending enormous
amounts of money into social projects to avert the uprising. Gov-
ernment expenditures have increased in the forms of various food
subsidies and bonuses for employees. Thus, the higher spending is
the result of the prevailing political uncertainty that generated
higher domestic financial liquidity.
Similarly, M2 has a positive impact on GPR approximately 2014
since the phase difference is in the range of ½ p=2; 0 with an
average coherency of 0.8 and a frequency of 1e2 years. The GPR
remained low during the period and the liquidity in the national
economy was sufficient. The repo rate and bills remained un-
changed by the SAMA to encourage banks' lending. However, GPR is
positively leading M2 in 2018, which means that as the uncertainty
increases, the liquidity position improves. Saudi Arabia's confron-
tation of Yemen rebels has brought serious threats to oil resources.
This clash coupled with the sanctions that were imposed by the U.S.
on Iran, which may curtail oil exports, has generated the uncer-
tainty. Additionally, the upward trend in shale oil production,
which can cover the production cuts of OPEC, has also increased the
level of uncertainty. Though the OP has already risen to 73 dollars
per barrel, Saudi Arabia is expecting to increase the OP above 80
dollars. The low OP has translated into a reduction in government
spending, which affects financial liquidity.
8 C.-W. Su et al. / Energy 187 (2019) 116003

Fig. 4. The wavelet coherency and the phase difference between GPR and M2. Notes: The y-axis refers to the frequencies (measured in months); the x-axis refers to the time period
1998:01e2018: 08. the y-axis refers to the frequencies (measured in years); The color bar on the right side corresponds to the strength of the correlation at each frequency. The black
contour shows the 5% significance level which is obtained by Monte- Carlo-simulations with 1000 replications. . (For interpretation of the references to color in this figure legend,
the reader is referred to the Web version of this article.)

The results for the relationship OPs and financial liquidity in the
presence of GPR are reported in Fig. 5. It reveals that the presence of
GPR increases the duration of the impact, which is stronger and has
a significant impact on M2 from 2001 to 2003. The terrorist attacks
and subsequent Afghanistan and Iraq invasions in 2003 increased
the level of uncertainty [64]. Similarly, oil production declined due
to the internal strife in Venezuela in April 2002. Such events have
generated political uncertainty, which has consequences for the
exporting countries. Additionally, the strained relationship be-
tween the U.S. and Saudi Arabia led to an expected government
change that would prevent oil supplies from triggering uncertainty.
This precarious scenario has resulted in a low OP, which means
lower revenues are available for government spending and this
could affect the liquidity [33].
We discover that OP positively causes M2 from 2004 to 2006 in
the short term. Figs. 2 and 3 demonstrate that by examining the
separate impacts of GPR on both OP and M2, there is no relationship
during the same period. Nonetheless, when GPR is present in the
nexus between OP and M2, they have a significant relationship. The
growing demand from developing economies and the low level of
political turmoil in the region have led to an increase in OP. Simi-
larly, there are few concerns about the supply and the low GPR. This
rising OP results in increased revenues, which are reflected in the
expanding domestic liquidity. Correspondingly, we notice a posi-
tive impact of M2 on OP from 2009 to 2010 in the short term. These
results are similar to the work of Ratti and Vespignani [62] which
reports that M2 has a significant influence on OP. During the time,
GPR was low and most of the countries had recovered from the
shock of the financial crisis. This development increased oil de-
mand, increased OPs and financial liquidity continued to increase
with the increase in government expenditures. Furthermore, SAMA
implemented an accommodative monetary policy to achieve
financial stability and consolidate the economy according to banks'
liquidity in order to increase lending to the private sector. Fig. 3
displays OP's short-term impact on M2 in 2013, and it shows that
it coincides with the uncertainty that the Arab Spring might disrupt
the oil supply. The recorded economic growth in emerging coun-
tries was slow due to the lack of demand and the OP hovered
approximately 108 dollars per barrel. Nevertheless, at the regional
level, Saudi Arabia is affected by the Arab Spring, which might be a
possible threat to the country. Subsequently, political risk was
controlled in the form of providing various food subsidies and
bonuses to government employees. Hence, the higher government
expenditures are the result of the prevailing GPR that caused higher
financial liquidity at the domestic level. The above empirical anal-
ysis is further supported by Appendix B for the robustness.
7. Discussion and policy implication
GPR is essential in determining OPs and their ultimate impact on
financial liquidity. Oil is viewed as a strategic resource and is a
source of conflict. In particular, GPR plays an essential role in the
OPs for oil exporting countries such as Saudi Arabia that are heavily
dependent on oil revenues. We observed a significant correlation in
the time domain between OPs and financial liquidity during the
time when the GPR was high. Especially, during two geopolitical
crises, i.e., the 2001 terrorist attacks and the Iraq war in 2003, OPs
increased, since both events increased the level of uncertainty and
fears about oil supply disruptions due to their link with the Middle
East. During the period, GPR remained high and OPs started
increasing. For Saudi Arabia, it was a blessing in disguise, and the
country seized the opportunity by increasing its supply of oil to the
world market, which resulted in considerable revenues. We notice
a time of prosperity from 2004 to 2007 when OPs showed an
 C.-W. Su et al. / Energy 187 (2019) 116003 9

Fig. 5. The partial wavelet coherency and the partial phase difference between OPs and M2, with GPR as a control variable. Notes: The y-axis refers to the frequencies (measured in
months); the x-axis refers to the time period 1998:01e2018: 08. the y-axis refers to the frequencies (measured in years); The color bar on the right side corresponds to the strength
of the correlation at each frequency. The black contour shows the 5% significance level which is obtained by Monte- Carlo-simulations with 1000 replications. . (For interpretation of
the references to color in this figure legend, the reader is referred to the Web version of this article.)

increasing trend and both regional countries, and the world were
less violent. Furthermore, the rising OPs were fueled by the
increasing demand from emerging economies, which provided
substantially increased revenues to Saudi Arabia and positively
impacted financial liquidity. However, these massive incomes were
utilized to overcome the effects of low OPs from 2008 to 2009 that
were caused by the low demand due to the recession. Meanwhile,
financial liquidity was dominant from 2010 to 2012, highlighting
that the government spent massive amounts of funds on various
subsidies to quell the expected social unrest that most of the
regional countries were confronting. GPR can be detrimental in the
long term because less oil revenues can be utilized for develop-
ment. This study shows that in the absence of GPR, the impact of
OPs on financial liquidity becomes more prominent in the short to
medium terms. It underlines that in case of no GPR, there will be a
more pronounced contribution of OPs to financial liquidity.
Meanwhile, in terms of the frequency domain, we detect a signif-
icant relationship in the short and medium terms, suggesting that
correlation among the OPs, financial liquidity and GPR vary across
the frequencies. It demonstrates that increasing OPs have positive
impacts on the financial liquidity in both short and medium term
across different frequencies. Likewise, GPR exerts pressure on
financial liquidity and OPs in the short and medium terms,
respectively. However, in the absence of GPR, the significant
medium-term correlations are lower (Table 2 ).
This study derives some implication underlying the results.
First, the results indicate that OPs lead financial liquidity, indicating
a strong dependence of Saudi Arabia on oil revenues. There can be
financial liquidity problems if this stream of income is disrupted,
which can have severe consequences for the domestic economy.
Therefore, the government should have a liquidity cushion to
support the domestic economy during lower OPs in the short term.
Likewise, the country's considerable dependence on oil revenues
makes Saudi Arabia extremely vulnerable to external shocks.
Therefore, the government should not put all their eggs into one
basket but should diversify their economy to include more nonoil
resources that can make decisive contributions to economic
development. Additionally, foreign reserves could be maintained
using the Saudi Arabia riyal, which will provide security in the case
of fluctuations. Similarly, a sound banking system can help to
maintain domestic liquidity. Second, OPs are impacted by the
various macroeconomic factors, and global uncertainty is one of
those that can have a significant role in determining prices. The
results also verify that during geopolitical uncertainty, OPs start
fluctuating and result in considerable government expenditures,
especially in the defense sector, which consumes large revenues.
Thus, the government should reduce their subsidies and spending
to military companies and divert the spending to investment pro-
grams. Similarly, when facing higher GPR, the benefits of OPs have
minimum impacts on financial liquidity in the short run. Mean-
while, it becomes more effective in the medium run in the absence
of GPR. Therefore, the government should make efforts to solve the
regional conflicts that will transmit the maximum benefits of the
OP to the domestic economy.
8. Conclusion
This paper employs wavelet analysis to explore the connection
among geopolitical risk (GPR), oil prices (OPs) and financial
liquidity in Saudi Arabia. The outcomes reveal that OPs and finan-
cial liquidity are significantly correlated in the time domain and are
coincidental with periods of higher uncertainties. Similarly, OPs
10 C.-W. Su et al. / Energy 187 (2019) 116003

Table 2
Relationship between the GPR, financial liquidity and OP.

Variables Term of relationship Time period Lead-lag Relationship Lead-lag Relationship

OP4M2 Medium 2e4 years 2002e2003, OP lead M2

Medium (2e4 years) 2004e2007 synchronously
Short term (1e2 years) 2008e2009 M2 lead OP
GPR4OP Medium term (2e4 years) 2000e2003 GPR leads OP
Medium term (2e4 years) 2008e2009 GPR leads OP
GPR4M2 Short term (1e2 years) 1999e2002 GPR leads M2
Short term (1e2 years) 2010e2012 GPR leads M2
Short term (1e2 years) 2014e2015 M2 leads GPR
(OP4M2)/GPR Medium term (2e4 years) 2001e2003 OP leads M2
Short and medium run (1e4 years) 2004e2006 OP leads M2
Short and medium run (1e4 years) 2009e2010 M2 leads OP

and financial liquidity synchronously moved from 2003 to 2008,
and GPR has significant short-term impacts on both OPs and
financial liquidity in the time domain. Meanwhile, OPs, financial
liquidity and GPR vary across the frequencies in both the short and
medium terms. Moreover, when we eliminate GPR, the results
show a significant relationship between OPs and financial liquidity
in the medium run. Our results support the monetary equilibrium
model that explains the transmission channels from GPR to OPs
and, finally, to financial liquidity. The government should diversify
their revenue sources, which will assist in absorbing the shocks to
the domestic market in the event of any OP volatility. Likewise, GPR
plays an important role in determining OPs and results in higher
government expenditures, especially public subsidies and weapons
that should be replaced by investment programs. The government
should utilize their efforts to resolve the regional conflicts, which
will transmit the maximum benefits from OPs to the domestic
economy.
Similarly, the y-axis denotes the frequencies (measured in months);
the x-axis refers to the time period. The y-axis mentions to the
frequencies. The color bar on the right side corresponds to the
strength of the correlation at each frequency. The black contour
shows the 5% significance level. The relationship is evaluated
among OPs, financial liquidity and GPR in three different ways.
First, the lead-lag relationship is assessed between OPs and finan-
cial liquidity. Second, the relationships between GPR and OPs and
between GPR and financial liquidity are respectively estimated.
Third, the partial coherency is used to assess the impacts of GPR on
the causality between OPs and financial liquidity.

Declaration of interests

The authors declare that they have no known competing

financial interests or personal relationships that could have
appeared to influence the work reported in this paper.

Appendix

A. The wavelet analysis interpretations

As the wavelet analysis is a complex technique explaining the

relationship in time and frequency domain which need proper
interpretation. Therefore, we added step by step explanation of the
wavelet method that improve the methodology application. It has
been used in several studies i.e. Aguiar-Conraria and Soares [5e9];
Rua [66e68]; Rua & Nunes [69]. The base of the wavelet approach
that it replaces the Fourier Transform Technique and offers an edge
by considering in the causality relationship, both time and fre-
quency domain aspects [8]. It anticipates instinctively both time
and frequency variation characteristic in a definite window. Simi-
larly, this method detects the causal link and co-movement over
the same point of time, as well as the changes. The wavelet co-
herency estimates the correlation between the two-time series in
time and frequency while phase difference detects the lead-lag
relationship.
The time series move in the same direction if the phase differ-
ence is zero. However, the variable will move in the opposite di-
rection if the phase difference is in the form of p (  p). WhenjAB 2
 such as Brent crude oil and Dubai and Tapis crude oil prices [74].
0; p2 , then AðtÞ positively Granger causes BðtÞ. When jAB 2 p
 2; p ,
BðtÞ negatively causes AðtÞ. If the phase difference is jAB 2  p; 
p , then the variable is removed of the phase and AðtÞ causes BðtÞ;
2 
and if the phase difference is jAB 2  p2;0 , then BðtÞ forecasts AðtÞ.
Fig. A. the lead-lag relationship
Note: The time series move in the same direction if the phase
difference is zero. However, the variable will move in the opposite
 if the phase difference is in the form of p (  p). When
direction
jAB 20; p2 , then the series is in phase, and A is leading B. If
jAB 2  p2; 0 , then B is leading A. However,
 if p (  p), this in-
dicates an anti-phase relationship. IfjAB 2 p2; p , then B is leading;
and if the phase difference is jAB 2 p; p2 , then A is leading B.
B. Robustness Test
As we have selected WTI for sample sections considers as a
regional benchmark recently. The Brent is viewed more related to
the Saudi Arabia. Thus, we test our results robustness using
different OPs for more convincing results. We reconsider the
wavelet coherency analysis with various international crude OPs
The estimated results using these three different crude oil prices
are consistent with the conclusion that is drawn when WIT was
used as the measure. The outcomes of these three different mea-
surements show that OPs, financial liquidity and GPR are
 C.-W. Su et al. / Energy 187 (2019) 116003 11

significantly correlated in the time domain. Similarly, in the fre-

quency domain, all three crude OPs render consistent results. The
results show that OPs, financial liquidity and GPR have significant
short and medium range relationships across the different fre-
quency domains. The findings indicate that GPR plays an important
role in OPs and financial liquidity in the short to mid-term. How-
ever, the results between OPs and financial liquidity reveal that
there is a mid-term correlation in the absence of GPR. In summa-
tion, we conclude that the findings are consistent after using the
Brent, Dubai and Tapis crude oil prices.2

Fig. B1. The wavelet coherency and the phase difference between OPs and M2.

Fig. B2. The wavelet coherency and the phase difference between GPR and M2.

2
The Dubai and Tapis Robustness results are the same and will be provided upon
request.
12 C.-W. Su et al. / Energy 187 (2019) 116003

Fig. B3. The wavelet coherency and the phase difference between GPR and OPs.

Fig. B4. The partial wavelet coherency and the partial phase difference between OPs and M2, with GPR as a control variable.

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