Work

Hedging political risk in international portfolios

Year: 2024

Type: article

Abstract: We show that internationally diversified portfolios carry sizeable political risk premia and expose investors to tail risk. We obtain political efficient frontiers with and without hedging political risk using a portfolio selection model for skewed distributions and develop a new asymptotic inference test to compare portfolio performance. Politically hedged portfolios outperform a broad market index and the equally weighted portfolio for US, Eurozone, and Japanese investors. Political risk hedging is not subsumed by currency hedging, and the diversification gains of politically hedged portfolios persist under currency hedging and transaction cost frictions. Hedging political risk induces equity home bias but does not fully explain the puzzle. • International portfolios with zero covariation with a global political risk P-factor. • Portfolio selection for skewed returns optimizing mean-to-CVaR performance ratio. • Asymptotically valid inference test for mean-to-CVaR ratios. • Diversification gains persist when political risk and currency risks are hedged. • Political risk hedging induces but does not explain the equity home bias puzzle.

Source: European Journal of Operational Research

DOI: 10.1016/j.ejor.2024.10.017

Authors: Somayyeh Lotfi, Giovanni Pagliardi, Efstathios Paparoditis, Stavros A. Zenios

Institutions: University of Central Lancashire Cyprus, BI Norwegian Business School, University of Cyprus, Durham University, Bruegel

Language: English

Topic: Risk and Portfolio Optimization

Subfield: Management Science and Operations Research

Field: Decision Sciences

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $3,290

Funders: University of St Andrews, University of Glasgow, Stony Brook University