Political Risk Insurance and Foreign Direct Investments
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Patrick L. Brockett
Political risk is an important consideration in the capital budgeting process for firms contemplating foreign direct investment (FDI) in emerging markets or in volatile political environments. Unfortunately, the unique characteristics of political risk make the application of familiar actuarially-based pricing models almost infeasible for valuating political risk insurance. In this article we employ utility theory instead to derive an equilibrium price (premium). This price maximizes an insurer’s expected profit and the insured’s expected utility, while taking into account the effects of risk control (self-protection) and risk financing (self-insurance). In addition, within this equilibrium framework, we derive the boundary level for the amount of foreign investment, the amount of political risk insurance coverage, and the minimum required rate of return of foreign investment. Finally, we employ a constant relative risk aversion (CRRA) utility function to illustrate the theoretical equilibrium model.
©2012 Walter de Gruyter GmbH & Co. KG, Berlin/Boston
Articles in the same Issue
- Featured Article
- Political Risk Insurance and Foreign Direct Investments
- Why Some Disaster Insurance Does not Exist
- Demographic Shift and Financial Markets in APEC: New Age Solutions to Age Old Challenges
- Modified Logistic Model for Mortality Forecasting and the Application of Mortality-Linked Securities
- Asymptotic Behavior of the Finite-Time Ruin Probability with Constant Interest Force and WUOD Heavy-Tailed Claims
- Risk Reporting Practices of Indian Companies in the SENSEX
Articles in the same Issue
- Featured Article
- Political Risk Insurance and Foreign Direct Investments
- Why Some Disaster Insurance Does not Exist
- Demographic Shift and Financial Markets in APEC: New Age Solutions to Age Old Challenges
- Modified Logistic Model for Mortality Forecasting and the Application of Mortality-Linked Securities
- Asymptotic Behavior of the Finite-Time Ruin Probability with Constant Interest Force and WUOD Heavy-Tailed Claims
- Risk Reporting Practices of Indian Companies in the SENSEX
