Political Risk in Emerging and Developed Markets

TLDR

Political risk is a stronger determinant of stock returns in emerging markets than in developed ones. The study investigates whether the differential impact of political risk on returns between emerging and developed markets will narrow if the trend continues. Analyst‑based estimates show that emerging markets with lower political risk earn about 11% per quarter more than those with higher risk, versus only a 2.5% quarterly advantage in developed markets, a statistically significant gap that has widened as political risk has declined in emerging and risen in developed markets over the past decade.

Abstract

Political risk represents a more important determinant of stock returns in emerging than in developed markets. Using analyst estimates of political risk, we show that average returns in emerging markets experiencing decreased political risk exceed those of emerging markets experiencing increased political risk by approximately 11 percent a quarter. In contrast, the difference is only 2.5 percent a quarter for developed markets. Furthermore, the difference between the impact of political risk in emerging and developed markets is statistically significant. We also document a global convergence in political risk. During the past 10 years, political risk has decreased in emerging markets and increased in developed markets. If this trend continues, the differential impact of political risk on returns in emerging and developed markets may narrow.