Political risk insurance

DETERMINANTS FOR POLITICAL RISK INSURANCE OF DIRECT INVESTMENTS IN EMERGING MARKETS
ABSTRACT
This paper analyzes the main determinants for investors to enter into political risk insurance (PRI) for its direct investments as well as the rationale for exiting PRI by not renewing its policies. This paper contributes to the existing PRI literature by investigating how major drivers for PRI, such as, political risks, economic risks, sponsor capacity, instrument used to invest (investment horizon) determine PRI schemes by using a non-linear binary response variable model. A unique database of the Multilateral Investment Guarantee Agency (MIGA) from 1990 to 2010, containing information on 693 investments including its coverage for: convertibility risk insurance, expropriation risk insurance, war and civil disturbance risks was utilized. However, we find that 47% do not remain active until the original contracted tenor. In addition, financial institutions as guarantee holders use more debt proportionally more than equity as an investment instrument, and are largely insured within the EU. On the other hand, BRICs investors tend to mainly cover its investments in infrastructure. Empirical findings include that an increase in breach of contract and civil unrest risks is fully correlated with the renewal of the insurance policies as well as the increased risk perception of the host country. The policies seem to bring a unique combination of coverage: for instance, a combination of breach of contract and transfer insurance is directly influenced by the breach of contract risk. Another preferred combination includes transfer risk and breach of contract insurance that are directly correlated to civil unrest risks.
Key words: Political Risk Insurance, Foreign Direct Investment Policy, Latin American Financial Markets

I. Introduction

The innovation that this paper brings to the existing foreign direct investments (FDI) literature is that it does not focus on the main