Geopolitical Risk Investing:

 

How to Use Game Theory for Strategic Asset Allocation in 2026

When China imposed sudden export restrictions on rare earth elements in late 2025, global markets convulsed. 

Tech stocks plummeted, commodity prices spiked, and emerging market currencies tumbled in unison. Investors who had carefully diversified their portfolios across geographies and asset classes watched helplessly as correlations converged and their hedges evaporated. The event underscored a harsh reality: in an era of strategic competition between nation-states, traditional diversification isn't enough.

Welcome to the new paradigm of geopolitical risk investing. In 2026, portfolio managers, CIOs, and macro strategists need more than Modern Portfolio Theory—they need to think like strategists. By applying game theory to model the moves and countermoves of geopolitical actors, investors can build portfolios that are truly resilient in the face of escalating tensions, trade wars, and power struggles.

Why Traditional Diversification Falls Short in Geopolitical Crises

The Limits of Modern Portfolio Theory

Modern Portfolio Theory (MPT) has been the bedrock of investment strategy for decades, but its foundational assumptions crumble under geopolitical stress. MPT assumes that asset returns follow a normal distribution and that correlations remain relatively stable—assumptions that work in calm markets but fail during crises.

Consider the 2008 financial crisis: assets that were historically uncorrelated—stocks, real estate, commodities—all declined in tandem. The diversification benefits that MPT promised vanished precisely when investors needed them most. The same pattern emerged during the escalation of US-China tensions in 2025.

When geopolitical tensions flare, the impact ripples through global supply chains simultaneously. A portfolio diversified across regions offers little protection because the underlying risk driver—strategic conflict between superpowers—affects all of them at once.

The New Reality: State-Level Strategic Games

Today's investment landscape is shaped by nation-states acting as strategic players in a high-stakes game. Economic policy is no longer just about growth—it's a tool of power projection. The US uses sanctions and export controls to constrain China's technological advancement. China responds by stockpiling strategic commodities and building alternative supply chains.

This is economic warfare, and it follows a logic that MPT doesn't capture. To navigate this environment, investors need to understand the strategic objectives of key players, anticipate their likely moves, and position portfolios accordingly. That's where game theory comes in.

Game Theory Fundamentals for Geopolitical Analysis

Key Game Theory Concepts for Investors

Game theory provides a framework for analyzing strategic interactions between rational actors—in this case, nation-states. Three concepts are particularly useful for investors:

Nash Equilibrium represents a stable state where no player can improve their outcome by unilaterally changing strategy. In geopolitical terms, it's a tense détente. For example, the current US-China relationship might be viewed as a Nash Equilibrium: both countries impose tariffs and export controls, neither achieves its ideal outcome, but neither wants to escalate to full economic decoupling because the costs would be catastrophic for both. The Prisoner's Dilemma explains why cooperation often fails even when it would benefit all parties. In trade relations, two countries might both be better off with free trade, but each has an incentive to impose tariffs to gain a short-term advantage. Fearing this, both impose tariffs, and both end up worse off. The US-China tariff escalations of recent years are a textbook example. Sequential Games model situations where players move in turns, allowing for escalation and de-escalation. When the US announces new semiconductor export controls, China must decide whether to retaliate with rare earth restrictions or pursue alternative strategies. Modeling these decision trees helps investors anticipate likely outcomes and position accordingly.

Mapping Geopolitical Players and Payoffs

To apply game theory effectively, investors must identify the key players, understand their strategic objectives, and assess their relative power positions.

In the US-China tech decoupling, the players are clear: the US seeks to maintain technological superiority and limit China's military capabilities; China aims for technological self-sufficiency and regional dominance; and multinational tech companies are caught in between, trying to maintain access to both markets.

Each player's payoffs are different. The US values national security over short-term economic efficiency. China prioritizes long-term strategic autonomy. Tech companies want to maximize profits but face regulatory pressure from both sides. By mapping these objectives, investors can predict likely moves. For instance, China's massive investments in domestic semiconductor production aren't just industrial policy—they're a strategic response to US export controls, and they create both risks (short-term inefficiency) and opportunities (new domestic champions) for investors.

Building a Game Theory Framework for Portfolio Positioning

Step 1: Scenario Development

Start by identifying critical geopolitical flashpoints: Taiwan, the South China Sea, US-China trade policy, and de-dollarization efforts by the BRICS bloc. For each flashpoint, model the likely actions and reactions of key players using game trees. Assign probabilities to different outcomes based on the strategic logic of each player's position.

Step 2: Asset Class Impact Analysis

Map each scenario to its likely impact on asset classes. A Taiwan crisis would likely trigger flight to the US dollar and Swiss franc, spikes in energy prices and gold, sharp declines in tech stocks dependent on Taiwan semiconductor production, and potential gains in defense stocks.

By conducting this analysis across multiple scenarios, you can identify assets that perform well across a range of outcomes—these become your core holdings.

Step 3: Strategic Allocation Adjustments

Based on your scenario analysis, adjust your portfolio to overweight assets that are resilient across multiple geopolitical outcomes. This might mean reducing exposure to sectors highly dependent on smooth US-China relations, increasing allocation to strategic commodities, building positions in defense and cybersecurity stocks, and maintaining flexibility through options to pivot quickly as the strategic game evolves.

Practical Strategies for Hedging Geopolitical Risk

Diversification 2.0: Beyond Geography

Traditional geographic diversification assumes that different regions are independent. In reality, they're linked by supply chains, trade relationships, and strategic alliances. A better approach is to diversify by geopolitical alignment and strategic resilience.

Consider supply chain exposure: A company manufacturing in Vietnam might seem like a hedge against China risk, but if it depends on Chinese components or serves the Chinese market, it's still exposed. True diversification means identifying companies and assets that are resilient to supply chain disruptions and can operate across different geopolitical blocs.

The de-dollarization trend offers another example. As central banks reduce their dollar reserves and increase gold holdings, investors should consider a broader basket of safe-haven assets rather than relying solely on US Treasuries.

Tactical Hedges and Asymmetric Bets

Specific hedging strategies for 2026 include currency hedges (long US dollar and Swiss franc), commodity plays (energy, rare earths, agricultural products), defense and cybersecurity stocks that benefit from increased government spending, and gold as the classic geopolitical hedge. Some investors are also exploring Bitcoin as "digital gold," though its volatility remains a concern.

Dynamic Rebalancing Based on Game State

Geopolitical games are dynamic. As players make moves, the strategic landscape shifts, and your portfolio should shift with it. Monitor escalation signals (new sanctions, export controls), de-escalation signals (diplomatic engagement, trade negotiations), and structural shifts (changes in alliances, technological breakthroughs).

The key is distinguishing signal from noise. Not every diplomatic spat requires portfolio adjustment, but structural shifts in the strategic game—like China's semiconductor self-sufficiency push or the BRICS de-dollarization efforts—demand a response.

Case Study: Navigating US-China Tensions in 2026

As we enter 2026, US-China relations remain the dominant geopolitical risk for global investors. From a game theory perspective, both countries are locked in a Prisoner's Dilemma. Full economic decoupling would hurt both economies, but each has incentives to gain strategic advantages in critical technologies. The result is a tense equilibrium with periodic escalations.

For investors, this creates distinct sector implications. Favor defensive sectors insulated from trade volatility, such as domestic renewable energy and nearshoring logistics. The semiconductor sector faces extreme volatility but also holds opportunities as China's self-sufficiency push creates new domestic champions and US companies benefit from CHIPS Act subsidies. As supply chains fracture, capital is flowing to other emerging markets in ASEAN and Africa that benefit from shifting trade corridors.

A resilient portfolio for 2026 might allocate 30% to high-quality government bonds, 25% to defense and strategic sectors, 15% to gold and safe-haven assets, 10% to energy and strategic commodities, 10% to resilient infrastructure, and 10% in cash for tactical flexibility.

Conclusion

Geopolitical risk isn't going away—if anything, it's intensifying as the post-Cold War order gives way to a multipolar world of strategic competition. Traditional diversification, built on the assumptions of Modern Portfolio Theory, offers false comfort in this environment.

The path forward requires thinking like a strategist. Game theory provides a structured framework for understanding the logic of geopolitical conflicts, anticipating likely moves, and identifying stable outcomes. By mapping scenarios, analyzing asset class impacts, and building strategic hedges, investors can construct portfolios that are truly resilient.

Your action plan for 2026:

1. Audit your portfolio's geopolitical exposures: Identify dependencies on smooth US-China relations, vulnerable supply chains, and concentrated regional risks.

2. Model key scenarios using game theory principles: What are the likely moves by major players? What are the stable equilibria? What are the tail risks?

3. Build strategic hedges and maintain flexibility: Allocate to assets that perform across multiple scenarios, use tactical hedges for specific risks, and keep dry powder for opportunities that emerge as the game evolves.

In a world of strategic competition, the investors who survive and thrive will be those who understand that markets are shaped by the power games of nations. By thinking strategically and positioning accordingly, you can turn geopolitical risk from a threat into an opportunity for resilient, long-term returns.