New Evidence on Economic Policy Uncertainty and Equity Risk Premium

61 Pages Posted: 24 Jan 2017

See all articles by Xiaoming Li

Xiaoming Li

Massey University - School of Economics and Finance (Albany)

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

Suggested Citation

Li, Xiaoming, New Evidence on Economic Policy Uncertainty and Equity Risk Premium (January 21, 2017). Available at SSRN: https://ssrn.com/abstract=2903346 or http://dx.doi.org/10.2139/ssrn.2903346

Xiaoming Li (Contact Author)

Massey University - School of Economics and Finance (Albany) ( email )

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