The Implications of a Global Rise in Equity Risk Premium

Proceedings of The 4th International Academic Conference on Management and Economics

Year: 2021

DOI:

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The Implications of a Global Rise in Equity Risk Premium

Jiaxin Zhang

ABSTRACT: 

Policy uncertainty increases due to the COVID-19 pandemic and U.S.-China trade war. The consumer and business confidence index in response to the increasing uncertainty indicates an overall pessimistic attitude towards future economic development. The uncertainty further causes the equity risk premium to rise. This paper explores the impact of a permanent increase in the global equity risk premium. A permanent 1 percent increase in equity risk premium in all six sectors across the United States and China are stimulated using the G-Cubed model, and the shock starts in 2020. The results show that the shock has various impacts on different macroeconomic variables over time. In the short run, as risk premium increases, capital outflows from China and the United States. Varies macroeconomic variables change in response to the outflow. Several variables gradually adjust back to the baseline level, while the others permanently decrease from the baseline over time. Moreover, the risk premium shock impacts China differently compared to the United States. The real GDP falls by more percent deviation from the baseline in China compared to in the United States in the long run. The real interest rate of China starts to increase from 2021 while the real interest rate continues to fall in the United States as monetary policy in China targets the exchange rate. In the short run, the investment of China decreases by less percent deviation from the baseline compared to the United States in response to the differences in real interest rate movement.

keywords: China, COVID-19 pandemic, G-Cubed model, Macroeconomic variables, The United States.