Risk Management: Foundations for a Changing Financial World

CHAPTER 41

COUNTRY RISK IN GLOBAL FINANCIAL MANAGEMENT^ao

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

FOREWORD

If you were an investor based in the United States in 1969, your portfolio probably did not contain any foreign securities. According to Brinson Partners, in that year, the worldwide investable capital market totaled the equivalent of US$2.3 trillion, about two-thirds of which rested in U.S. stocks and bonds. Therefore, as a U.S.-based investor, your failure to diversify internationally may well have been justified by the fact that you were already selecting from a reasonably complete set of securities. Furthermore, by remaining invested exclusively in dollar-denominated equities issued by companies whose products and services you knew, you might have convinced yourself that you were avoiding the myriad risks that attend offshore endeavors.

If you were an investor based in the United States in 1995, however, this sort of myopia was difficult to rationalize. By that year, the portion of the US$44.0 trillion global capital market invested in U.S. stocks and bonds had shrunk to barely 40 percent, despite a quarter century of remarkable prosperity in your country. By maintaining a strictly domestic portfolio, you failed to take advantage of almost 60 percent of the securities available to you.

What the preceding statistics underscore, of course, is that the world’s economy has become increasingly diverse. Although the ascent of Japanese securities accounted ...