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Journal of International Business Studies

, Volume 45, Issue 4, pp 471–493 | Cite as

Political risk spreads

  • Geert Bekaert
  • Campbell R Harvey
  • Christian T Lundblad
  • Stephan Siegel
Article

Abstract

We introduce a new, market-based and forward-looking measure of political risk derived from the yield spread between a country’s US dollar debt and an equivalent US Treasury bond. We explain the variation in these sovereign spreads with four factors: global economic conditions, country-specific economic factors, liquidity of the country’s bond, and political risk. We then extract the part of the sovereign spread that is due to political risk, making use of political risk ratings. In addition, we provide new evidence that these political risk ratings are predictive, on average, of future risk realizations using data on political risk claims as well as a novel textual-based database of risk realizations. Our political risk spread measure does not make the mistake of double counting systematic risk in the evaluation of international investments, as some conventional measures do. Furthermore, we show how to construct political risk spreads for countries that do not have sovereign bond data. Finally, we link our political risk spreads to foreign direct investment (FDI). We show that a 1% point reduction in the political risk spreads is associated with a 12% increase in net-inflows of FDI.

Keywords

political risk country risk sovereign spreads political risk news foreign direct investment (FDI) cost of capital 

Notes

Acknowledgements

This paper has benefitted from the comments of David Reeb and two anonymous referees. We benefitted from the comments of seminar participants at the AFA 2013 meetings, the 2012 Pacific Northwest Finance Conference, Banco Central de Reserva del Perú, Indian School of Business, Case Western Reserve University, Erasmus University, and the University of Virginia. We thank Jonathan Brogaard for sharing computer code to search global news. Siegel acknowledges the financial support from the Global Business Center at the University of Washington. Bekaert acknowledges financial support from Netspar. We appreciate the research assistance of Nicholas Alphin, Zeca Cardoso, Catriona Harvey, Thompson Teagle, Samuel Towne, and Eduardo Vanegas-Garcia.

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Copyright information

© Academy of International Business 2014

Authors and Affiliations

  • Geert Bekaert
    • 1
    • 2
  • Campbell R Harvey
    • 2
    • 3
  • Christian T Lundblad
    • 4
  • Stephan Siegel
    • 5
  1. 1.Columbia UniversityUSA
  2. 2.National Bureau of Economic ResearchCambridgeUSA
  3. 3.Duke UniversityDurhamUSA
  4. 4.University of North CarolinaChapel HillUSA
  5. 5.University of WashingtonSeattleUSA

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