Openness and the effect of business cycle synchronization on the equity risk premium

Natalia Gitelson and Eran Manes

Research in International Business and Finance, 2025, vol. 77, issue PA

Abstract: We augment the Lucas tree model by allowing diffusion from a leader to follower countries and use it to derive an equity risk premium (ERP) formula that features a positive effect of countries’ degree of business cycle synchronization on their ERP. Using panel data of 122 countries for the period 2012–2022, we empirically validate that countries' correlation of GDP gap with that of the U.S. has a positive effect on ERP. We further show that a size-adjusted measure of trade openness has a positive effect on ERP and that this effect is moderated by income. We conclude that investors perceive open economies with a high degree of business cycle synchronization as high-beta investments.

Keywords: Equity risk premium; Business cycle synchronization; Economic openness; International business cycle (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G15 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:riibaf:v:77:y:2025:i:pa:s0275531925001539

DOI: 10.1016/j.ribaf.2025.102897

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