Hedging Political Risk in International Equity Portfolios

60 Pages Posted: 24 Jul 2021 Last revised: 28 Mar 2023

See all articles by Giovanni Pagliardi

Giovanni Pagliardi

BI Norwegian Business School

Somayyeh Lotfi

University of Cyprus - Department of Accounting and Finance

Efstathios Paparoditis

University of Cyprus - Department of Mathematics and Statistics

Stavros A. Zenios

Durham University Business School; University of Cyprus; Cyprus Academy of Sciences, Letters, and Arts; Bruegel

Date Written: December 1, 2022

Abstract

Internationally diversified portfolios carry sizeable political risk premia and are exposed to tail risk. We develop a portfolio selection model to obtain political efficient frontiers and hedge political risk and devise an asymptotic inference test to compare portfolio performance. Empirical tests on a sample of 42 developed and emerging markets document that performance gains from international diversification persist when political risk is hedged, but screening ex-ante politically risky markets is inefficient. Political hedging is not subsumed by currency hedging, and the diversification gains of politically hedged portfolios increase for long-horizon investors. We also show that hedging political risk induces equity home bias. Our findings hold for US, Eurozone, and Japanese investors.

Keywords: Hedging, political risk, international diversification, equities markets, conditional Value-at-Risk, portfolio optimization.

JEL Classification: C12, C13, C61, F21, F30, G11.

Suggested Citation

Pagliardi, Giovanni and Lotfi, Somayyeh and Paparoditis, Efstathios and Zenios, Stavros A., Hedging Political Risk in International Equity Portfolios (December 1, 2022). Available at SSRN: https://ssrn.com/abstract=3891070 or http://dx.doi.org/10.2139/ssrn.3891070

Giovanni Pagliardi

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Somayyeh Lotfi

University of Cyprus - Department of Accounting and Finance ( email )

Cyprus

Efstathios Paparoditis

University of Cyprus - Department of Mathematics and Statistics ( email )

P.O. Box 20537
1678 Nicosia
Cyprus
00357-2-338701 (Phone)
00357-2-339061 (Fax)

Stavros A. Zenios (Contact Author)

Durham University Business School ( email )

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893605 (Phone)

HOME PAGE: http://https://www.researchgate.net/profile/Stavros_Zenios

Cyprus Academy of Sciences, Letters, and Arts ( email )

Nicosia
Cyprus

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

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