How Does Government Policy Affect Equity Risk Premium?

This study examines the effect of country-level governance quality on equity risk premium using a panel dataset of 122 developed, emerging and developing economies over the period 2000-2012. Governance quality is measured by worldwide governance indicators. We use other determinants of equity risk premium as independent variables in the model which are inflation, consumption preferences, economic risk, international financial integration and binary variable 'Crisis'. Our results show that better governance quality translates into lower equity risk premium. This paper has strong policy implications for policy makers. In fact, a good government policy is essential in order to attract foreign investors.