Political Risk in Hong Kong and Taiwan: Pricing the China Factor

Abstract

This paper measures how the risk associated with foreign direct investment in the prosperous, liberal economies of Hong Kong and Taiwan is affected by the prospect of reunification with the poor, politically and economically backward mainland. This China factor is modeled as a jump to a higher political risk level. I find that the China factor effect is substantial on Taiwan but still almost six times higher on Hong Kong. Nevertheless, Hong Kong's political risk is considerably lower than China's, thereby confirming the intuition that Hong Kong could be a lower risk back door avenue to the potentially lucrative Chinese market.

JEL Classification: G31