The international integration of the term structure of expected market risk premia

Abstract

Using option prices to extract expected market risk premia (ERP) across international stock markets, we show that the term structure of the ERP is slightly downward sloping, but its slope becomes steeply downward sloping during bad economic times. Indeed, formal tests show that shocks to international expected equity excess returns are highly integrated, especially during recessions. Moreover, as additional evidence of international integration, these expectation shocks impact in a similar way the realized returns of popular risk factors across stock markets. The exposures of risk factors to changes in ERP across international markets are highly integrated.