Financial and political risks in US direct foreign investment

TLDR: In this paper, the authors examined the risk of US direct foreign investments over the period 1982-98 in 59 host countries and found that unexplained country risk is qualitatively and quantitatively related to unobserved political risk.

Abstract: This paper examines the risk of US direct foreign investments over the period 1982–98 in 59 host countries. The first part of the analysis builds an empirical model to explain the time-series and cross-country patterns of return on capital. The estimation then uses the return on assets (ROA) as a measure of the return on capital, and investigates its determinants. There are four main findings. First, the ROA in a majority of countries does not simply track the worldwide ROA. Second, some cross-country differences are explained by financial risks. Third, unexplained country risk is qualitatively and quantitatively related to unobserved political risk. Fourth, unexplained country risk is also compensated with a higher ROA, enhancing its credibility as a measure of political risk. The unexplained country risk is thus used to calculate a new index of political risk ratings for 56 host countries that may be useful to managers, investors, policymakers, and academics.