Political Risk Spreads

Geert Bekaert, Campbell Harvey (cam.harvey@duke.edu), Christian Lundblad and Stephan Siegel (ss1110@uw.edu)

No 19786, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce a new, market-based and forward looking measure of political risk derived from the yield spread between a country's U.S. dollar debt and an equivalent U.S. Treasury bond. We explain the variation in these sovereign spreads with four factors: global economic conditions, country-specific economic factors, liquidity of the country's bond, and political risk. We then extract the part of the sovereign spread that is due to political risk, making use of political risk ratings. In addition, we provide new evidence that these political risk ratings are predictive, on average, of future risk realizations using data on political risk claims as well as a novel textual-based database of risk realizations. Our political risk spread measure does not make the mistake of double counting systematic risk in the evaluation of international investments as some conventional measures do. Furthermore, we show how to construct political risk spreads for countries that do not have sovereign bond data. Finally, we link our political risk spreads to foreign direct investment. We show that a one percent point reduction in the political risk spread is associated with a 12 percent increase in net-inflows of foreign direct investment.

JEL-codes: F21 F23 F36 G15 G31 H25 K33 M21 O16 O19 (search for similar items in EconPapers)
Date: 2014-01
New Economics Papers: this item is included in nep-pol and nep-rmg
Note: AP CF DEV IFM POL
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (92)

Published as Geert Bekaert & Campbell R Harvey & Christian T Lundblad & Stephan Siegel, 2014. "Political risk spreads," Journal of International Business Studies, Palgrave Macmillan, vol. 45(4), pages 471-493, May.

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