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Political Risk and Irreversible Investment

  • Sumru G. Altug
  • Fanny S Demers
  • Michel Demers

The objective of this article is two-fold. First, we develop a theoretical model to investigate the impact of political risk on irreversible investment. Second, we apply our model to an analysis of the effects of risk of separation of the province of Quebec from the Canadian federation. We model the probability of a regime switch using the properties of the electoral process and examine the response of investment to changes in the risk of separation. We consider the impact of investors' perception of the risk of separation and financial market volatility separately. We show that political risk has a depressing impact on investment even if the 'bad' regime has never been observed in the sample. (JEL Codes: E22, D92, O16, O11) Copyright , Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/cesifo/ifm014
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Article provided by CESifo in its journal CESifo Economic Studies.

Volume (Year): 53 (2007)
Issue (Month): 3 (September)
Pages: 430-465

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Handle: RePEc:oup:cesifo:v:53:y:2007:i:3:p:430-465
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  1. James E. Anderson & Eric van Wincoop, 2000. "Gravity with Gravitas: A Solution to the Border Puzzle," Boston College Working Papers in Economics 485, Boston College Department of Economics.
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