Country Risk and Expected Returns across Global Equity Markets

Abstract

Assessing and pricing country risk poses a considerable challenge to tactical asset allocation across national equity markets. This research examines the relationship between the country composite risk (together with its component risks related to: sovereign credit, currency, banking sector, economic structure, and political situation) and the expected returns, also identifying general investment practice implications. The equal-weighted portfolio of risky countries proved to outperform the safe countries by approximately 0.50 percentage points per month. The application of this cross-sectional pattern, however, still poses a significant challenge for investment practice. The abnormal performance proved insignificant for capitalization-weighted and liquidity weighted portfolios, as well as within the subgroups of the full sample. We also observed profitability of the risk-based strategies disappear in the years following the global financial crisis.