Conference Agenda

Country risk premia include compensation for global political risk. Political risk premia drive international returns within and across asset classes, including equities, bonds, and currencies. A strong factor structure in politically sorted portfolios uncovers systematic variations in global political risk (P-factor). The P-factor commands a significant risk premium of 4.44% per annum with a Sharpe ratio of 0.70. Together with the global market portfolio, it explains up to three-quarters of cross-sectional variation in a large panel of asset returns. The P-factor is unspanned by the existing asset pricing factors, manifests in all asset classes, and is related to systematic variations in expected global growth and aggregate volatility.

We show that during United governments, where the same political party controls the White House, the Senate, and the House of Representatives, the U.S. stock market earns substantially higher equity premia and the U.S. economy experiences higher economic growth than during Divided governments. We refine the presidential puzzle (Santa-Clara and Valkanov, Journal of Finance 2003) into a Divided-Republican government puzzle since United-Republican presidents earn comparable or higher equity premia than Democratic presidents from either government. Cross-sectionally, a striking SMB difference of 7% per annum arises across the government cycle. We use close-tie election results to infer causality, and show that the government cycle also holds for the UK. Our results are consistent with theoretical models relating lower returns during Divided-Republican governments to rising political uncertainty, higher sentiment as well as to the famous September effect.

We develop a novel measure of media attention to U.S. populism by extending an existing populist dictionary to capture the new form of populism. Our Aggregate Populist Rhetoric (APR) Index spikes around well-known events that spur populist sentiment and exposure to APR is linked to financial globalization. We show that the APR Index is priced in the cross-section of currency excess returns. Currencies that perform well (badly) when attention to U.S. populism is high yield low (high) expected excess returns. Investors require a risk premium for holding currencies that underperform in times of rising attention to U.S. populism. Financial segmentation explains why friction to globalization in the form of populism affects the cross-section of currency returns.