Emerging Markets: Stock Market Investing with Political Risk

EFMA 2001 Lugano Meetings

Middlesex University Business School Discussion Paper No. 6

Cass Business School Research Paper

21 Pages Posted: 14 May 2001

See all articles by Ephraim Clark

Ephraim Clark

Middlesex University Business School

Radu Tunaru

University of Sussex

Date Written: May 2000

Abstract

Besides market risk, stock market investments in emerging markets are also exposed to political phenomena that are not generally present in the more developed economies. This problem is well known to banks and multinational companies as country or political risk. Assessment techniques in these domains are relatively well developed but unadapted to portfolio investment in that they tend to ignore the diversification aspect associated with cross country correlations. In this paper we address the problem of political risk with cross country correlations. We develop a model for simultaneously measuring the cost of political risk in several countries that retains most of the characteristics of the single country risk model in terms of its ability to price political risk based on the stochastic process of exposure to loss and the expected frequency of loss causing events. It generalizes the one company-one country approach, however, in that a multivariate approach is taken and correlations across countries are considered directly. The technique developed here can be implemented into a decision support program, providing a feasible solution to the ongoing difficulty of apprehending the multivariate nature of political risk and integrating it into the process of portfolio management.

Keywords: Portfolio investment, political risk, insurance policy, geometric Brownian motion, Poisson arrival process.

JEL Classification: D81, F23, G22, G31

Suggested Citation

Clark, Ephraim and Tunaru, Radu, Emerging Markets: Stock Market Investing with Political Risk (May 2000). EFMA 2001 Lugano Meetings, Middlesex University Business School Discussion Paper No. 6, Cass Business School Research Paper, Available at SSRN: https://ssrn.com/abstract=268749 or http://dx.doi.org/10.2139/ssrn.268749

Ephraim Clark (Contact Author)

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Radu Tunaru

University of Sussex ( email )

Jubilee
Brighton, BN1 9SL
United Kingdom

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