The risk and predictability of equity returns of the EU accession countries

Abstract

This paper investigates the importance of global risk factors and the predictability of returns of the 13 EU accession countries, using both unconditional and conditional asset-pricing tests during the turbulent period of 1997–2002. Applied for the first time to the full sample of EU accession countries, we conclude that the world excess return has only somewhat importance for Hungary, Poland and Turkey, indicating low financial liberalization and low integration with the world. The real G-7 interest rate followed by the world excess return, global foreign exchange rate and global inflation rates are the most influential in their explanation of the variation of local market returns. Predictability of local returns is high and variant; global instrumental variables have higher predictive power for eight countries, especially for Bulgaria, Cyprus, Estonia, Lithuania, Romania and Hungary, whereas local instruments are more important for the Czech Republic, Latvia, Poland and Slovenia. The failure of the conditional asset-pricing model to correctly price assets confirms partial integration with the world. Except for Bulgaria, Hungary, Latvia and Malta, predictability cannot be explained by time variation in economic risk premiums, but by local information, market inefficiency and/or investor irrationality.