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Foreign Investing Risk And Credit Default Swaps
The credit default swaps market can give investors keener insight about volatile foreign markets. By Patrick T. Drum
MOST OVERSEAS MARKETS OUTPACED THE S & P 500 last year, and a significant number of U. S. companies are now trading at pre-financial crisis valuations, so investors and advisors alike may be looking to increase their allocation to foreign investments while minimizing the home country bias lurking in their portfolios.
However, notwithstanding their attractive valuations, solid relative returns and geographic diversification, overseas investments raise a host of due diligence and risk considerations.
That’ s especially true in frontier markets where there might be military conflicts, say in regions like the Middle East, which many investors likely feel is too much risk to take on. But even here, per- ception sometimes bears little resemblance to reality.
To be sure, the longstanding conflicts in the Middle East give investors understandable pause and make them wonder about the region’ s stability( and the performance of its markets). But investors usually conflate what the market is actually pricing in with their own perceptions of price.
And there’ s a distinction to be made there, because investors often overestimate the market volatility caused by conflicts, while underestimating the volatility stemming from political events such as elections that can influence a sovereign government’ s debt sustainability. It usually surprises investors that the market is more attuned to those measures of fiscal and debt stability than it is to military conflict.
A good way to measure that is to look at changes in key financial indices over the seven business days after a critical event to see what the market prices in. In that critical period, key facts and information often emerge for investors to assess— and it’ s not too long afterward that other market factors start to show influence.
That seven days also offers sufficient time for heightened emotions to settle as financial markets close over a weekend, giving ample time for investors to“ reprice” financial assets.
Signals
Our firm decided to use an empirical method of evaluating market perception— we looked at four different key financial metrics after a geopolitical shakeup to see if it prompted investors to sell assets such as equities and reallocate to safer things such as government bonds.
The four metrics were:
• The changes in a country’ s stock market after an event;
• The changes in yields of two-year and 10-year government bonds;
• The changes in a country’ s currency relative to the U. S. dollar; and
• The changes in the country’ s credit default swaps.
MARCH / APRIL 2026 | FINANCIAL ADVISOR MAGAZINE | 41