The Effect of Political Risk on Foreign Investment Flows and Financial Market Performance in Emerging Economies

Posted: Feb 11, 2025

• Mateo Smith
• Matthew Clark
• Matthew Green

Abstract

This research investigates the complex relationship between political risk, foreign investment flows, and financial market performance in emerging economies through a novel methodological framework that integrates computational social science with financial econometrics. We develop a multi-dimensional political risk index that captures both traditional institutional factors and unconventional behavioral indicators derived from social media sentiment and political discourse analysis. Our approach differs significantly from existing literature by incorporating real-time digital footprints of political sentiment and employing machine learning techniques to predict investment responses to political events. The study analyzes data from 25 emerging economies over a 15-year period, revealing that political risk affects foreign investment through multiple transmission channels including institutional quality, policy predictability, and social stability. Our findings demonstrate that certain types of political risk have non-linear effects on investment flows, with threshold effects that previous research has overlooked. The research contributes to both theoretical understanding and practical risk assessment methodologies by providing a more nuanced framework for evaluating political risk in emerging markets. The results have important implications for international investors, policymakers, and financial institutions operating in volatile political environments.