Political Risk, Economic Risk and Financial Risk

Fuqua School of Business Working Paper No. 9606

41 Pages Posted: 8 May 2000 Last revised: 7 Aug 2020

See all articles by Claude B. Erb

Claude B. Erb

TR

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Tadas E. Viskanta

Ritholtz Wealth Management

Date Written: May 6, 1996

Abstract

How important is an understanding of country risk for investors? Given the increasingly global nature of investment portfolios, we believe it is very important. Our paper measures the economic content of five different measures of country risk: The International Country Risk Guide is political risk, the financial risk, economic risk and composite risk indices and Institutional Investoris country credit ratings. First, we explore whether any of these measures contain information about future expected stock returns by conducting trading simulations. Next, we conduct time-series-cross-sectional analysis linking these risk measures to future expected returns. Second, we investigate the relation between these measures and other, more standard, approaches to risk exposures. Finally, we analyze the linkages between fundamental attributes within each economy, such as book-to-price ratios, and the risk measures. Our results suggest that the country risk measures are correlated future equity returns. We find that the country risk measures are correlated with each other, however, financial risk measures contain the most information about future equity returns. Finally, we find that country risk measures are highly correlated with country equity valuation measures. This provides some insight into the reason why value-oriented strategies generate higher returns.

Keywords: Country Risk Assessment, Mean-Reverision of Risk, Country Trading Strategies, Risk Exposure

JEL Classification: F30, F36, G12, G15

Suggested Citation

Erb, Claude B. and Harvey, Campbell R. and Viskanta, Tadas, Political Risk, Economic Risk and Financial Risk (May 6, 1996). Fuqua School of Business Working Paper No. 9606, Available at SSRN: https://ssrn.com/abstract=7437 or http://dx.doi.org/10.2139/ssrn.7437

Claude B. Erb

TR ( email )

CA 90272
United States

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)

HOME PAGE: http://www.duke.edu/~charvey

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tadas Viskanta

Ritholtz Wealth Management ( email )

24 West 40th Street
New York, NY 10018
United States

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