Determinants of Cross-Country Differences in the Equity Risk Premium: A Cross-Sectional Analysis

The equity risk premium (ERP) is a critical factor in financial decision-making and allocating capital for the future. The ERP can indicate the aggregate risk in an economy and thereby the price agents attach to that risk. Understanding the factors that determine ERPs across countries is important for understanding investors’ actions in a globalized environment. This study will focus on long-run measures of the ERP across countries while applying four common measures. Variations in the size of the ERP across countries and across measures will be examined. Then, country-specific determinants of the long-run ERP will be investigated. These determinants include macroeconomic factors such as the volatility of GDP growth and inflation volatility as well as political and cultural factors such as property rights, trust and ethnic fractionalization. This study will not only contribute to the understanding of risk and return in a globalized investment environment but will also identify those factors which reduce or increase a country’s equity risk premium.