Political risk everywhere

Abstract

Country risk premia include compensation for global political risk. Political risk premia drive international returns within and across asset classes, including equities, bonds, and currencies. A strong factor structure in politically sorted portfolios uncovers systematic variations in global political risk (P-factor). The P-factor commands a significant risk premium of 4.44% per annum with a Sharpe ratio of 0.70. Together with the global market portfolio, it explains up to three-quarters of cross-sectional variation in a large panel of asset returns. The P-factor is unspanned by the existing asset pricing factors, manifests in all asset classes, and is related to systematic variations in expected global growth and aggregate volatility.

Keywords: Political risk, international equities, bonds, FX, asset pricing.

JEL Classification: E62, F30, G15, G18