A Note on Political Risk and the Required Return on Foreign Direct Investment

This note analyzes the impact of political risk on investors' required return and the multinational corporation's cost of capital on foreign direct investment using the basic diversifiable-nondiversifiable dichotomy of portfolio theory. Whether or not a particular political risk affects the value of a multinational corporation through its cost of capital depends on whether the risk is related to investors' relevant market portfolios. We provide a numerical example that illustrates the potential impact of political risk on required return.

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