Hedging against political risks enhances international stock portfolio performance more effectively than diversification alone, according to a study involving Professor Stavros Zenios.
The study, conducted by Stavros Zenios, Professor of Operations Management and Finance, in collaboration with his former PhD students Somayyeh Lotfi (University of Central Lancashire) and Giovanni Pagliardi (BI Norwegian Business School), as well as Professor of Statistics Efstathios Paparoditis (University of Cyprus), explored the impact of political risk hedging on investment portfolios.
The researchers discovered that managing political risk enables investors to build stronger, more resilient portfolios while retaining the advantages of international diversification. This approach boosted performance for investors in key markets such as the US, Eurozone, and Japan.
The researchers aimed to compare how hedging political risks affected a broad market index, a benchmark representing the overall performance of diverse investments. With international portfolios increasingly exposed to political risks – from regional conflicts and climate change to electoral backlash - the research investigated how investment managers can make portfolios more resilient.
The authors analysed historical data on monthly returns from 1999-2019, covering international portfolios from a broad sample of 22 developed and 20 emerging markets. They assessed each country’s political risk using an asset pricing model with a political risk factor (P-factor).
The team then tested a model to evaluate whether hedging against significant political events and unexpected shocks positively influence portfolio performance. They applied this model for American, European, and Japanese investors, both during the studied timeframe and in more recent periods beyond the dataset.
The findings revealed that hedging political risks proved effective during unexpected shocks, such as those triggered by the COVID-19 pandemic and the war in Ukraine. However, political risk hedging often led investors to concentrate more on their home markets.
The researchers urge portfolio managers to incorporate these findings into their strategies, particularly when investing in emerging economies with high political risk. To maximise portfolio performance, investors should prioritise hedging political risks alongside diversification.
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