The Explanatory Power of Political Risk in Emerging Markets

There is substantial argument that political risk is an important and increasing influence on international portfolio allocation decisions. The purpose of this paper is to investigate the relation between political risk and stock returns within the context of emerging markets. The issue is examined using a framework that controls for global and local return influences. Consistent with the paper's predictions, the findings reveal that political risk is important in explaining return variation in individual emerging markets, particularly in the Pacific Basin, but not in developed markets. At an aggregate portfolio level, supportive evidence is found of a positive relation between political risk and ex-post returns in emerging markets that is robust to alternative risk measures, and more prevalent during the 1990s.

[1]  E. Fama,et al.  Risk, Return, and Equilibrium: Empirical Tests , 1973, Journal of Political Economy.

[2]  Dan Stefek,et al.  Emerging Markets , 1992 .

[3]  Robert Z. Aliber,et al.  The Interest Rate Parity Theorem: A Reinterpretation , 1973, Journal of Political Economy.

[4]  Campbell R. Harvey,et al.  PREDICTABLE RISK AND RETURNS IN EMERGING MARKETS , 1999 .

[5]  Llewellyn D. Howell,et al.  Models of political risk for foreign investment and trade: An assessment of three approaches , 1994 .

[6]  W. G. Prast,et al.  POLITICAL RISK AS A VARIABLE IN TNC DECISION‐MAKING , 1982 .

[7]  James D. Hamilton.  Time Series Analysis , 1994 .

[8]  Campbell R. Harvey.  The risk exposure of emerging equity markets , 1995 .

[9]  Geert Bekaert,et al.  Market Integration and Investment Barriers in Emerging Equity Markets , 1995 .

[10]  E. Fama,et al.  Size and Book-to-Market Factors in Earnings and Returns , 1995 .

[11]  G. William Schwert,et al.  Stock Volatility and the Crash , 1990 .

[12]  V. Errunza.  Gains from Portfolio Diversification into Less Developed Countries' Securities , 1977 .

[13]  V. Errunza.  Emerging Markets: A New Opportunity for Improving Global Portfolio Performance , 1983 .

[14]  Bernard Dumas,et al.  International Portfolio Choice and Corporation Finance: A Synthesis , 1983 .

[15]  Philippe Jorion,et al.  The Pricing of Exchange Rate Risk in the Stock Market , 1991, Journal of Financial and Quantitative Analysis.

[16]  Re-Emerging Markets , 1997 .

[17]  Bruno H. Solnik,et al.  An equilibrium model of the international capital market , 1974 .

[18]  Expropriation of private foreign investment , 1974 .

[19]  W. Bailey,et al.  Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market , 1995, Journal of Financial and Quantitative Analysis.

[20]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[21]  Option Pricing and Foreign Investment under Political Risk , 2001 .

[22]  Susmita Dasgupta,et al.  Return Behavior in Emerging Stock Markets , 1995 .

[23]  R. M. Stulz,et al.  A model of international asset pricing , 1981 .

[24]  Campbell R. Harvey,et al.  Foreign Speculators and Emerging Equity Markets , 1997 .

[25]  H. Huizinga,et al.  Barriers to portfolio investments in emerging stock markets , 1992 .

[26]  V. Errunza,et al.  Tests of integration, mild segmentation and segmentation hypotheses , 1992 .

[27]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[28]  E. Fama,et al.  Dividend yields and expected stock returns , 1988 .

[29]  Campbell R. Harvey,et al.  The Dynamics of Emerging Market Equity Flows , 1999 .

[30]  B. Dumas,et al.  The World Price of Foreign Exchange Risk , 1993 .

[31]  Paul D. Koch,et al.  Economic determinants of evolution in international stock market integration , 1999 .

[32]  David A. Jodice.  Political Risk Assessment: An Annotated Bibliography , 1985, American Political Science Review.

[33]  Campbell R. Harvey,et al.  Political Risk, Economic Risk and Financial Risk , 1996 .

[34]  Stephen R. Blough.  The Relationship between Power and Level for Generic Unit Root Tests in Finite Samples , 1992 .

[35]  E. Perotti,et al.  Privatization, Political Risk and Stock Market Development in Emerging Economies , 1999 .

[36]  C. Inclan,et al.  Volatility in Emerging Stock Markets , 1997, Journal of Financial and Quantitative Analysis.

[37]  John M. Liew,et al.  Political Risk in Emerging and Developed Markets , 1996 .

[38]  P. Henry.  Stock Market Liberalization, Economic Reform, and Emerging Market Equity Prices , 2000 .

[39]  T. Moran,et al.  Multinational Corporations and the Politics of Dependence: Copper in Chile , 1975 .

[40]  Jean-Marc Suret,et al.  Political Risk and the Benefits of International Portfolio Diversification , 1995 .

[41]  Campbell R. Harvey,et al.  Time-Varying World Market Integration , 1994 .

[42]  S. Kothari,et al.  Stock return variation and expected dividends: A time-series and cross-sectional analysis , 1992 .