There's No Magic Pill to Treat Political Risk

Our concept of political risk looks in need of an overhaul. After companies from BP Plc to Renault SA walked away from businesses worth billions of dollars in Russia, what was a subset of finance has moved to center stage. The withdrawal prompted by the invasion of Ukraine has focused minds on the prospect of a far more damaging divorce should a similar crisis develop with China — a much bigger economy that is more deeply integrated into global supply chains. Current theory and practice appear inadequate to cope.

Peruse the finance literature, and political risk features mostly via the question of how much compensation investors should demand to put money into markets with dodgier legal systems and greater corruption. One conventional method is to look at the relative volatility of assets in these economies compared to a global index. Such an approach is wholly insufficient to capture the scale of what are in effect catastrophic tail risks. There is no database of returns that can help multinationals model the once-in-a-lifetime chance of being forced to pull out of one of their most important markets.