International stock return predictability: The role of U.S. uncertainty spillover

Abstract

This paper explores the implications of U.S. uncertainty for cross-country asset pricing. We propose a global common spillover index of U.S. uncertainty (GSIU) based on the Partial Least Square method, and show that this index is a powerful predictor of aggregate stock returns around the globe, both in- and out-of-sample. Additionally, we find that GSIU affects stock returns through both cash flow and discount rate channels. Furthermore, our index is linked to well-known pricing factors, namely that an increase in GSIU is generally associated with a deteriorating macroeconomic condition, higher levels of stock market volatility and economic policy uncertainty, increased disaster risk, as well as pessimistic investor sentiment, both domestically and internationally.