The Impact of Political Risk on Equity Market Performance

Abstract: This paper investigates the impact of political risk on financial performance. In order to assess the quantitative measure of political risk principal component analysis is performed referring to six indicators, which measure different areas of political environment. We employ several macroeconomic factors as control variables to strenghten the explanatory power of estimation. Panel data methods are used to test the impact of political risk. It turns out that political risk is not priced in equity returns, while results are sensitive to the time span changes. We show that the impact on price-to-earnings ratio is negative and statistically significant implying that investors are willing to pay less for stocks with higher risk. Dividend yields respond positively, but the regression has weak explanatory power. Among macroeconomic variables, GDP turns to have a significant influence on all the financial performance measures. Additionally, the effects of unemployment, exchange rate movements, interest rates and reserves on returns are statistically significant. To conclude, the paper demonstrates the existence of the impact of political risk proxies and various macroeconomic indicators on equity market performance.