<A HREF="../../ordert.htm">Order Copy of Paper</A><P> Financial Analysts Journal (1996): Forthcoming.

Political Risk, Economic Risk and Financial Risk

Claude B. Erb
First Chicago Investment Management Co., Chicago, IL

Campbell R. Harvey
Duke University, Durham, NC 27708
National Bureau of Economic Research, Cambridge, MA

Tadas E. Viskanta
First Chicago Investment Management Co., Chicago, IL


We measure the economic content of five different measures of country risk: The International Country Risk Guide's political risk, the financial risk, economic risk and composite risk indices and Institutional Investor's country credit ratings. First, we explore whether any of these measures contain information about future expected stock and bond returns by conducting trading simulations. Next, conduct time-series-cross-sectional analysis linking these risk measures to future expected returns. Second, we invesigate the relation between these measures and other, more standard, approaches to risk exposures. Finally, we analyze the linkages between fundamental attributes within each economy, such as price-to-book ratios, and the risk measures. Our results suggest that the country risk measures are correlated future equity returns. For bond returns, the country risk measures do not predict either the unhedged or hedged returns suggesting that the information is only relevant for future local currency bond returns and currency forward premia/discounts. We also find that the country risk measures are highly correlated with each other, however, financial risk measures contain the most information about future equity returns. Finally, we find that country risk measures are highly correlated with country equity valuation measures. This provides some insight into the reason for higher returns for value-oriented strategies.