Risk Management: Foundations for a Changing Financial World

CHAPTER 42

POLITICAL RISK IN THE WORLD ECONOMIES^ap

Marvin Zonis

Because the state must provide the crucial economic, financial, legal, and political infrastructure for the operation of any market economy, political risk considerations need to be part of every investment decision. The model presented here to assess political risk uses 10 variables that have historically been highly predictive of political instability; the presentation reveals the Top 10 and Bottom 10 of mid-1997.

International investors appear to be ignoring considerations of political risk in their asset valuations. This strategy could be dangerous. States play an immense role in economic life, so the fates of governments are immensely significant to all international investors. This presentation reviews the role of political risk analysis in investment markets and discusses the key drivers of a political risk stability model that I developed two years ago. The political risk rankings produced by the model of the 10 most stable and 10 least stable of 65 countries and some notes on China and Russia follow.

POLITICAL RISK ANALYSIS

Market prices suggest that political risk is not a particularly relevant factor in the minds of international investors. For example, the spreads for sovereign debt—not only of Italy and Spain versus France and Germany but also of the emerging markets—have all narrowed. Furthermore, the November/December 1996 issue of the Financial Analysts Journal contains an article in which the authors ...