Political Risk, Economic Risk, and Financial Risk

Claude B. Erb, Campbell R. Harvey and Tadas E. Viskanta

Financial Analysts Journal, 1996, vol. 52, issue 6, 29-46

Abstract: Given the increasingly global nature of investment portfolios, an understanding of country risk is very important. This article addresses the economic content of five different measures of country risk: four measures from the International Country Risk Guide's political-, financial-, economic-, and composite-risk indexes and one from Institutional Investor's country credit ratings. We explored whether any of these measures contain information about future expected stock returns. We conducted time-series/cross-sectional analysis linking these risk measures to future expected returns. Finally, we analyzed the links between fundamental attributes such as book-to-price ratios within each economy and the risk measures. The results suggest that the country-risk measures are correlated with future equity returns. In addition, such measures are highly correlated with equity valuation measures. This finding provides some insight into the reason that value-oriented strategies generate high average returns.

Date: 1996
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DOI: 10.2469/faj.v52.n6.2038

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