Macro Risk

What is Macro Risk?

Macro risk is a type of political risk that can impact all businesses operating within a country. Macro risk can be political in nature or caused by macroeconomic factors outside of government control. Common examples of macro risk include changes in monetary policy, shifts in the regulatory or tax regime, and political or civil unrest.

Understanding Macro Risk

Macro risk impacts all asset classes that are exposed to a particular country or region. Imagine a country, for example, that has elected a government opposed to foreign influence and interference. Any company that engages in foreign direct investment (FDI) or has operations within the country would face tremendous macro risk, because the newly elected government could expropriate any and all foreign operations, regardless of industry.

Many organizations and academics issue reports that assess a country's or region's degree of macro risk. Furthermore, companies have the opportunity to purchase political risk insurance from a variety of organizations to mitigate potential losses.

Macro Risk and the Impact on the Market

Macro risk is both a short- and long-term concern for financial planners, securities traders, and investors. Some of the macroeconomic factors that can influence macro risk include unemployment rates, interest rates, exchange rates, and commodity prices.

Some macro risks will have a greater impact on a particular sector than on others. Changes in environmental regulations, for example, tend to impact the mining and energy industries more than other industries. However, the repercussions for these industries can then ripple through an economy if mining and energy are significant sources of investment and jobs.

Unemployment rates, interest rates, exchange rates, and commodity prices are macroeconomic factors that can influence macro risk.

Macro risk is an important factor for stock traders and institutions to consider in their financial and risk models. Most macro risks are addressed in valuation models like the arbitrage pricing theory (APT) and the modern portfolio theory (MPT) families of models.

Valuation models and closely related fundamental analysis models also consider macro risk as a factor. Understanding how macro risk influences the intrinsic value of a particular investment is important because when the factors change values, errors can be introduced in the corresponding intrinsic value forecasts.

Macro Risk and International Investment Flows

Investors also look at macro risk to gauge the political stability and the general growth opportunities in other countries. There are several types of annual international rankings of countries that provide insight into their relative political and social stability and how that correlates with potential economic growth.

Investors can take action either by investing directly into a country or by investing in regionally oriented funds. With some emerging markets, the growth story can be compelling even if the macro risks are significant. If an investor is diversified over enough markets, the macro risks of any particular investment become more manageable from a portfolio perspective.