Where to make an investment? If home political risk occurs

Abstract

n this paper, we put political risk into the model of international asset allocation to analyze international investors’ decisions. We assume that when home investors have perceived home political risks, they override other factors of their portfolio decision and move to hold more foreign assets to hedge those risks. To model political risk, we use a stochastic differential equation with a Poisson jump diffusion process to simulate international asset allocation. The numerical result confirms our hypothesis, i.e., foreign bias exists. That is, home investors would prefer to hold more foreign assets than the optimal asset allocation to hedge against home political risk