Hedging political risk in international portfolios

Lotfi, Somayyeh; Pagliardi, Giovanni; Paparoditis, Efstathios; Zenios, Stavros A

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.

Citation

Lotfi, S., Pagliardi, G., Paparoditis, E., & Zenios, S. A. (online). Hedging political risk in international portfolios. European Journal of Operational Research, https://doi.org/10.1016/j.ejor.2024.10.017

• Journal Article Type: Article
• Acceptance Date: Oct 11, 2024
• Online Publication Date: Oct 18, 2024
• Deposit Date: Sep 10, 2024
• Publicly Available Date: Oct 18, 2024
• Journal: European Journal of Operational Research
• Print ISSN: 0377-2217
• Electronic ISSN: 1872-6860
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• DOI: https://doi.org/10.1016/j.ejor.2024.10.017
• Keywords: Block bootstrapping; conditional Value-at-Risk; equity home bias puzzle; in- ternational diversification; portfolio selection; higher-order moments
• Public URL: https://durham-repository.worktribe.com/output/2854231