New Evidence on Economic Policy Uncertainty and Equity Risk Premium
61 Pages Posted: 24 Jan 2017
Date Written: January 21, 2017
Abstract
Contrary to the recently reported US evidence of a negative premium, this study shows that China’s economic policy uncertainty (EPU) commands a positive equity risk premium. Motivated by the observation that Chinese stock traders have a strong risk appetite and a cognitive bias, we modify the assumption underlying the orthodox ICAPM framework to derive hypotheses consistent with the Chinese context, and test them based on multifactor models. We find that stocks with higher EPU betas earn significantly higher average returns. Loadings on the EPU factor incrementally and positively forecast the cross-section of returns on portfolios and individual stocks.
Keywords: Equity premium, Government policy uncertainty, Risk appetite, China
JEL Classification: G1, G12, G32, G02
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