Political Risk in Emerging and Developed Markets

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.