International Politics and Policy Risk Factors

Abstract

Using novel measures of politics and policy uncertainty we document predictable variation in stock market returns across countries. Investment strategies that exploit the politics-policy predictability generate abnormal annualized returns up to about 14% based on existing international asset pricing models. We propose two new politics and policy risk factors, and document that countries with lower politics and policy rankings are exposed to these priced global risk factors, earning higher average returns. The new factors are not spanned by existing factors, and, when augmenting the international market factor, significantly reduce pricing errors, and improve overall fit by an order of magnitude.