Does Policy Instability Matter for International Equity Markets?
International Review of Finance, Forthcoming
56 Pages Posted: 23 Jul 2013 Last revised: 2 Mar 2019
Date Written: July 20, 2018
We test whether policy risk is systematically priced in equity returns across 49 countries from 1995 to 2013. We construct two global policy risk factors based on the ratings from international country risk guide. They capture the policy risk from government instability (GOVLMH) and the quality of bureaucracy (BURLMH). Both factors are significantly and positively related to equity returns and the BURLMH factor carries a monthly risk premium of 65 basis points. A country with weaker economic and institutional conditions has more risk exposure to the BURLMH factor whereas a country with high democracy has more risk exposure to the GOVLMH factor. Overall, our study reveals the importance and complexity of policy risk in international equity markets.
Keywords: bureaucratic quality, government stability, international asset pricing, policy instability
JEL Classification: G15, G18
Suggested Citation: Suggested Citation