Political Risk in International Business

							            MANAGING RISK IN
        INTERNATIONAL BUSINESS
                          Techniques and Applications




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
           The Three Steps to Effective
                International Risk
                  Management

                     Identifythe individual risks
                     Assess risk magitudes and exposure
                      levels
                     Incorporate the risk assessment in the
                      decision making process


Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                                     Political Risk

                  Definition
                  Sources
                  Assessment                   techniques




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
               Modern Tools of Financial
                  Decision Making

                                     Requiredinput:
                                         MARKET DATA
                                           – Mean-variance analysis
                                           – Contingent claims analysis
                                           – Modigliani-Miller



Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
             Shortcomings of Traditional
                    Techniques
                                     Unsuited   to modern financial
                                        decision making
                                          – data
                                          – parameters
                                          – applications
                                     Generally     imprecise and
                                        difficult to apply

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                       The New Framework
                        Overcomes These
                          Shortcomings
                                     Uses  market data (international
                                      prices)
                                     Generates parameters compatible
                                      with modern portfolio and option
                                      pricing theory




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                       Generating the Data:
                           Four Steps

        Establish accounting                             discipline
        Define income flows
        Define expenditure flows
        Link income and expenditure to the balance
         sheet


Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                  Important New Decision
                    Making Parameters

        Macroeconomic   profits
        Market value of the economy
        The economy’s rate of return
        The economy’s financial risk premium
        The economy’s systematic risk (beta)



Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
    Assessing Country Specific
          Financial Risk

        Estimate               standard deviation of country rate
         of return
        Estimate total amount of foreign debt and
         its duration
        Apply the information in the Black-Scholes
         option pricing formula

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
            New Parameters: Examples
        The financial risk premium
        Insolvency or illiquidity
        The maximum debt level
        Implied volatility




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                            A Big Question

                    DOES IT WORK?


Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                         CLARK vs         .
                              EUROMONEY
                         The Forecast 1988
        The   Clark forecast: Euromoney, September
            1988, page 234
              – 60 countries
        The    EUROMONEY forecast: Euromoney,
            September 1988, page 235
              – 117 countries


Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
              CLARK vs. EUROMONEY
                 The Result 1993
                 Exhibit 6.9 - Percent of Unrescheduled Debt at Each
                                                   Rank

                                                       1

                                                    0,8                   Clark
                                                    0,6

                                                    0,4

                                                    0,2
                                                             Euromoney
                                                       0
                  1    5    9   13 17 21 25 29 33 37 41 45 49 53 57




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                 Estimating Systematic Risk

 Construct                the World Index
      – Estimate macroeconomic market value for each
        country
      – Sum the market values of all countries to create the
        world index
 Regress    country returns against percentage
     change in world index to estimate Beta

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
             Performance Measurement

                 INTERNATIONAL
                   PORTFOLIOS

Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                  Money Market Portfolios
                       1982-1991
                            Optimized            GDP weights         Equal weights        Jap-Ger-Switz


       Arithmetic.                 13%                  12%                11.8%                11.0%
       mean

       Geometric                  12.7%               11.2%                11.1%                 9.9%
       mean

       Standard                   7.5%                13.3%                12.4%                15.7%
       deviation

       Return/SD                 1.733%               0.902%                0.952              0.701%




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
         Long Term Government Bond
                  Portfolios
                 1982-1991
                            Optimized            GDP weights         Equal weights        Jap-Ger-Switz


       Arithmetic                  14%                12.4%                12.5%                11.8%
       mean

       Geometric                  13.5%               11.6%                11.8%                10.8%
       mean

       Standard                    11%                13.2%                13.2%                15.7%
       deviation

       Return/SD                 1.273%               0.939%               0.950%              0.753%




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                               Equity Portfolios
                                 1982-1991
                            Optimized            Equal weights       Equal weights        Jap-Ger-Switz
                                                 with US             without US

       Arithmetic                20.11%               15.89%               16.77%              17.45%
       mean

       Geometric                 17.44%               14.2%                14.83%              14.92%
       mean

       Standard                  25.56%               20.64%               22.08%              25.85%
       deviation

       Return/SD                0.7868%              0.76.99%             0.7596%              0.6750%




Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
               Excess Return to Risk for
                  Selected Portfolios
                      1982-1991
                                 Optimized                 Equal Weights             Jap-Ger-Switz


       Money market                       0.700                     0.331                     0.210


       LT govt. bond                      0.567                     0.364                     0.261


       Equity index                       0.484                     0.409                     0.375


       Source: E. Clark, “A general International market index”,International Journal of Finance,
       vol. 3, (1995) 1288-1312



Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr
                                              Outline
        Brief review                   of traditional international risk
         analysis
        Presentation of new techniques
        Applications
              – direct investment
              – portfolio investment
              – cross border loans


Ephraim CLARK, 43 rue Louis Rouquier, 92300 Levallois-Perret, France, Tel: 33-1-47-57-72-34. eclark@club-internet.fr