Hedging political risk in international portfolios

Somayyeh Lotfi, Giovanni Pagliardi, Efstathios Paparoditis and Stavros A. Zenios

European Journal of Operational Research, 2025, vol. 322, issue 2, 629-646

Abstract: We show that internationally diversified portfolios carry sizeable political risk premia and expose investors to tail risk. We obtain political efficient frontiers with and without hedging political risk using a portfolio selection model for skewed distributions and develop a new asymptotic inference test to compare portfolio performance. Politically hedged portfolios outperform a broad market index and the equally weighted portfolio for US, Eurozone, and Japanese investors. Political risk hedging is not subsumed by currency hedging, and the diversification gains of politically hedged portfolios persist under currency hedging and transaction cost frictions. Hedging political risk induces equity home bias but does not fully explain the puzzle.

Keywords: Block bootstrapping; Conditional value-at-risk; Equity home bias puzzle; International diversification; Portfolio selection; Skwewed returns (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:322:y:2025:i:2:p:629-646

DOI: 10.1016/j.ejor.2024.10.017

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