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Country Risk and Global Equity Selection

Journal of Portfolio Management, Winter (1995): 74-83

Claude Erb

First National Bank of Chicago, Chicago, IL 60670, USA

Campbell R. Harvey

Duke University, Durham, NC 27706, USA

National Bureau of Economic Research, Cambridge, MA 02138, USA

Tadas Viskanta

First National Bank of Chicago, Chicago, IL 60670, USA


What is a meaningful way of thinking of risk in a global setting? In developed markets, factor models provide a reasonable characterization of the sensitivity of particular market returns to global economic forces. In emerging markets, these factor models suggest that the risk exposure is essentially zero. This, of course, runs counter to intuition and suggests that these factor models are misspecified. We investigate an alternative risk measure based on country credit risk. This measure is survey based and by construction forward looking. We find that country credit risk has the ability to differentiate between expected returns as well as volatility in our sample of 40 countries. Out-of- sample portfolio selection based on credit risk rating dominates strategies based on traditional measures such as the cross-section of dividend yields.