Fiscal Origins of International Factor Structures

This paper links the US fiscal condition to the common variations in risk premia driving global risky asset prices. I find that deteriorations in the US fiscal condition i) coincide with elevated levels of global risk premia and ii) predict higher future global equity returns at short, medium and long run horizons. Driving these results are two key forces: i) global long run risks (LRRs) and ii) global uncertainty. I find that deteriorations in the US fiscal condition coincide with i) depressed global growth expectations and ii) elevated levels of global uncertainty. I argue that these findings are the equilibrium outcome of a novel recursive risk-sharing scheme where the US insures the rest of the world (ROW) against positive US fiscal shocks. This argument is formalised using a stylised multi-country, multi-good model with i) Epstein and Zin (1989) preferences and ii) frictionless markets where US fiscal policy drives global growth news