1. 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

2. Unfortunately, this case is on the program because of September 11.
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 U.S. has become much more risky
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 August 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