The Explanatory Power of Political Risk in Emerging Markets

Abstract

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 other local return influences. Consistent with the paper's predictions, the findings reveals that political risk is more important in explaining return variation in emerging markets, particularly in the Pacific-Basin, than in a comparative sample of developed markets. At an aggregate 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.