Political risk insurance

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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, suchas, 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 maindeterminants for investors to invest, but on how they protect their investments with political risk insurance (PRI) contracts and the rationale for exiting these contracts by not renewing its policies. It investigates how major drivers for PRI, such as, political risks, economic risks, sponsor capacity and instrument used to invest (investment horizon) determine PRI compositions by utilizing anon-linear binary response variable model.
The underlying macroeconomic rationale is that foreign direct investments (FDI) have become the major driver of globalization and the most profound effect has been seen in developing countries (DC), where yearly foreign investment flows have increased from an average of less than U$ 10 billion in the 1970s to U$ 533 billion in 2010 and now comprise 38% oftotal FDI. China is at the forefront of FDI growth, followed by Brazil, Russia, India and Mexico.
Because we are analyzing insurance policies, risk analysis is crucial. Therefore, the risks under analysis are non-commercial and commonly classified as political risks which evolve out of government action and affect investment decisions in the target country. Equity, shareholder loans and loans,the most common investment instruments utilized for FDI, can be insured against four types of political risks: convertibility, expropriation, war and civil disturbance and breach of contract.
A unique database of the World Bank’s Multilateral Insurance Guarantee Agency (MIGA) from 1990 to 2010 containing information on 693 investments, including its coverage for the risks listed above, contracttenor, amount, host and investor countries and investment instrument is utilized along with country political risk data from the Belgium Public Insurer Office National Du Ducroire Nationale Delcrederienst (ONDD). MIGA’s database was selected because it is the only multilateral agency that does not favor any particular country.
The World Bank database was also utilized for control variables....
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