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Track M7-5: The Cross-Section of Stock, Bond and Currency Returns
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Political risk everywhere 1Morningstar Investment Management LLC; 2BI Norwegian Business School; 3University of Wisconsin-Madison; 4Durham University and University of Cyprus We show that 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, and 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.
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