A Political Capital Asset Pricing Model
74 Pages Posted: 18 Mar 2019 Last revised: 12 Aug 2019
Date Written: March 12, 2019
Abstract
We construct a bivariate factor of political stability and economic policy confidence and show that it commands a significant premium of up to 15% per annum, in the global, developed, and emerging markets, robust to ICAPM, Fama-French five-factor model, Carhart, and ICAPM Redux. We propose an international capital asset pricing model incorporating the political factor, and test global and local estimations in developed and emerging economies. The model explains up to 77% of cross-sectional returns, has good predictive power, in several tests it performs better than the benchmark models in pricing equity indices and explains up to an incremental 25% of cross-sectional returns and is robust out of sample.
Keywords: asset pricing, political uncertainty, economic policy uncertainty, international stock markets, emerging markets, frontier markets
JEL Classification: E62, F30, G12, G15, G18
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