A Political Capital Asset Pricing Model

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, Carhart, and ICAPM Redux. We propose an international capital asset pricing model incorporating the political factor, and test estimations in the global, developed, and emerging markets. The model explains up to 77% of cross-sectional returns, has good predictive power, 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.