Political uncertainty and international investment diversification: Cross country evidence

We investigate whether political uncertainty as a result of a temporary rise in unpredictability about future government policy and leadership surrounding national elections affects how investors allocate their investments between home and foreign equity markets. Using panel data of 49 countries from 2001 to 2019, we find that political uncertainty exerts a positive and significant effect on equity home bias, but, in contrast, political uncertainty leads to a significant reduction in equity foreign bias. Our findings suggest that, whereas political uncertainty induces over-investment in equity holdings of domestic investors, the converse is the case for foreign investors. Our results also show that institutional quality and information environment moderate the effects of political uncertainty on home and foreign biases. Our channel analysis indicates that differences in information between home and foreign investors explain how investors make their investment decisions during the period of political uncertainty.