Political Risk

Definition

Political risk refers to the risk that an investment's returns could suffer due to political changes or instability in a country. This instability affecting investment returns may stem from government changes, legislative shifts, decisions by foreign policymakers, or military control. Political risk is also known as 'geopolitical risk'.

Origin

The concept of political risk emerged in the mid-20th century as globalization and international investments increased, making investors aware of the impact of political events on economic activities. During the Cold War, political risk became a focal point for multinational companies and investors due to geopolitical tensions that could lead to market volatility.

Categories and Features

Political risk can be categorized into macro and micro risks. Macro risks affect all investors in a country or region, such as regime changes or wars. Micro risks affect specific industries or companies, such as nationalization policies targeting particular sectors. The features of political risk include unpredictability and potentially high impact, requiring investors to exercise caution in decision-making.

Case Studies

A typical case is the oil industry in Venezuela. Due to government policy changes and nationalization measures, many foreign oil companies suffered significant losses on their investments in the country. Another example is Brexit, which led many companies to reassess their investments in the UK due to increased political and economic uncertainty.

Common Issues

Investors often worry about how to assess and manage political risk. A common misconception is that political risk only exists in developing countries, whereas developed countries can also face political risks, such as uncertainties arising from policy changes or election outcomes. Investors can mitigate these risks through diversification and purchasing political risk insurance.