Expected Market Returns in the International Cross-Section

Abstract

Two recent articles, Martin (2017) and Chabi-Yo and Loudis (2019), derive a lower bound for the expected market risk premium that does not require parameter estimation and can be computed in real time. Based on evidence from 15 international markets, we cannot reject the hypothesis that these expected return lower bounds are tight. Furthermore, asset pricing factors that are insignificant in asset pricing tests if realized returns are used as expected return proxy become significant when expected market risk premium lower bounds are used instead; for example, the lower bound is higher for countries with greater exposure to global and regional stock markets and for countries with high exposure to the dollar and carry factors. Finally, we find that a strategy that takes a long position in markets with relatively high expected returns and a short position in markets with relatively low expected returns, yields statistically significant positive returns that are not explained by traditional risk factors.