International Stock Market Co-Movements and Politics-Related Risks

72 Pages Posted: 25 Mar 2019

See all articles by Giovanni Pagliardi

Giovanni Pagliardi

BI Norwegian Business School

Patrice Poncet

ESSEC Business School; Universite Paris I Pantheon Sorbonne

Date Written: March 12, 2019

Abstract

We investigate the determinants of international stock market co-movements, shedding light on the relevance of politics-related factors. We propose a new characterization for the link connecting politics and financial markets, disentangling two different components: political risk and economic policy risk. We uncover the surprisingly low correlation between the two variables, and show they are priced differently by the market. We implement a pairs trading strategy, in the spirit of Gatev et al. (2006), which loads on international stock market co-movements. Exclusively relying on hard macro-data proves not to be sufficient to explain the statistically significant and economically large returns generated by the strategy. We show how to increase the abnormal returns (alphas) generated by the strategy by exploiting shorter-time co-movements. We document the utmost relevance of political risk, which explains and predicts returns driven by both short-term and long-run correlations. Our analysis also unveils the relevance of confidence factors, especially foreign investors' confidence, which should therefore be accounted for when assessing the co-variation of international stock market prices.

Keywords: international stock markets, political risk, economic policy risk, pairs trading, predictive regressions, CDS spreads, abnormal returns

JEL Classification: G12, G15

Suggested Citation

Pagliardi, Giovanni and Poncet, Patrice, International Stock Market Co-Movements and Politics-Related Risks (March 12, 2019). Available at SSRN: https://ssrn.com/abstract=3351453 or http://dx.doi.org/10.2139/ssrn.3351453

Giovanni Pagliardi (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Patrice Poncet

ESSEC Business School ( email )

Avenue Bernard Hirsch
BP 105 Cergy Cedex, 95021
France
33 1 3443 3000 (Phone)
33 1 3443 3001 (Fax)

Universite Paris I Pantheon Sorbonne ( email )

Finance Department, UFR 06
17 rue de la Sorbonne
75005 Paris
France
33 1 40 46 2783 (Phone)
33 1 40 46 33 66 (Fax)

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