Firm-level Political Risk and Credit Markets
45 Pages Posted: 12 Jun 2019
Date Written: May 28, 2019
We examine the effect of firm-level political risk on debt markets. While prior research relies mainly on economy-wide proxies for political risk (such as the economic policy uncertainty index), Hassan et al.  suggests that a substantial part of political risk plays out at the firm-level. We use their measure of political risk to show that borrower-level political risk is reflected in the pricing and liquidity of public debt, the cost of private debt, and credit default swap spreads and recovery rates. We also document the strength of pricing effects for persistent versus temporary variation in firm-level political risk.Furthermore, we show that lender-level political risk influences the supply of credit and has a significant effect on loan pricing. Taking advantage of the granularity of our measure, we also show that firm-specific changes in political risk propagate across firms and lenders, suggesting the importance of network effects in amplifying the effects of political uncertainty. Finally, we show that borrowers and lenders can mitigate the effect of political risk via political activism and through changes to contractual terms.
Keywords: credit markets, political risk, financial institutions
JEL Classification: G21, G18, P16
Suggested Citation: Suggested Citation