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Managing Geopolitical Risk In Investment Decision Making

Sixth Global Fixed Income Capital Markets/Investment Management Workshop/Retreat July 20-24, 2002 Aspen, Colorado. Managing Geopolitical Risk In Investment Decision Making. Campbell R. Harvey Duke University and National Bureau of Economic Research. The Risk Setting.

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Managing Geopolitical Risk In Investment Decision Making

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  1. Sixth Global Fixed Income Capital Markets/Investment Management Workshop/Retreat July 20-24, 2002 Aspen, Colorado Managing Geopolitical Risk In Investment Decision Making Campbell R. Harvey Duke University and National Bureau of Economic Research

  2. The Risk Setting • Unfortunately, this case is on the program because of September 11. • Risk management advances have been focused largely on market risks, i.e. VaR models • Now, there is significant interests in managing GPR

  3. The Risk Setting • Big picture issues • Is GPR “diversifiable” or “systematic”? • Uncertainty versus risk? • How does GPR fit into an investment management strategy?

  4. The Risk Setting • Some reading: • Campbell R. Harvey, 1994, “National Risk and Global Fixed Income Allocation,” with C. Erb and T.E. Viskanta, Journal of Fixed Income. • Campbell R. Harvey, 1996, “Political Risk, Financial Risk and Economic Risk,” with C. Erb and T.E. Viskanta, Financial Analysts Journal. • Campbell R. Harvey, 1996, “The Influence of Political, Economic and Financial Risk on Expected Fixed Income Returns,” with C. Erb and T.E. Viskanta, Journal of Fixed Income. • Campbell R. Harvey, 2000, “The Drivers of Expected Returns in International Markets,” Emerging Markets Quarterly.

  5. The Risk Setting • The U.S. has become much more risky • High sensitivity to some GPRs • Disagreement on strength of economy • Financial information less credible

  6. U.S. Has Become a Riskier Global Investment ICRG Political Risk

  7. U.S. Has Become a Riskier Global Investment ICRG Political Risk

  8. U.S. Has Become a Riskier Global Investment Risk Ratings July 2002

  9. U.S. Has Become a Riskier Global Investment Risk Ratings May 2001

  10. U.S. Has Become a Riskier Global Investment Higher risk means equity investors require a higher rate of return

  11. U.S. Has Become a Riskier Global Investment • Regression equation implies an increase in the medium-term risk premium of 240bp • This helps explain the recent decline in the equity market • This helps explain the recent behavior of the U.S. dollar • This helps explain the slow down in real investment (hurdle rates are up)

  12. Diamond Asset Management Company • Previous CIO “fallen on the sword” because of failure to have detailed contingency plans for GP events – like September 11 • Diamond characterized as “geopolitical planning void”

  13. Diamond Asset Management Company • First attempt to develop a strategy

  14. U.S. Has Become a Riskier Global Investment

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