Economic Echoes of Conflict: Evaluating the Palestine-Israel War’s Influence on Middle Eastern Markets

Abstract

This study examines the Palestine-Israel conflict’s effects on Middle Eastern financial markets, including conventional and Islamic indices. Employing wavelet cross-correlation, global VAR (GVAR), and Granger causality analyses, we identify complex patterns in pre-conflict geopolitical risk (GPR) and stock returns, including diverse lead/lag behaviors and amplitude fluctuations. Post-conflict, these dynamics show smoother adjustments and stronger cross-correlations. The pre-conflict wavelet GVAR analysis reveals country-specific reactions to anticipated GPR shocks, marked by asymmetric responses starting around 20 days post-shock and varying across nations. This period also features significant shock spillovers in stock returns, both positive and negative. During the conflict, initial reactions include substantial spikes in raw stock returns, suggesting possible co-crash scenarios. These evolve into predominantly positive short-term shock spillovers, with medium and long-term responses suggesting stock markets as potential safe havens. Lastly, wavelet Granger causality analysis reveals bidirectional causality between GPR and stock returns over the long term, with specific countries showing varied causality patterns during the conflict. The inclusion of Islamic indices demonstrates homogeneous responses to GPR shocks, similar to conventional markets, highlighting the integrated nature of these markets. This study underscores the complex temporal dynamics of market responses to geopolitical shocks and provides insights for policymakers and investors.