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Political Risk and Irreversible Investment

  • Sumru G. Altuğ


    (Department of Economics, Koç University; Center for Economic Policy Research, London.)

  • Fanny S. Demers
  • Michel Demers

The objective of this paper is twofold. 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.

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Paper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 0707.

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Length: 51 pages
Date of creation: May 2007
Date of revision:
Handle: RePEc:koc:wpaper:0707
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  1. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
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