Global and country-specific business cycle risk in time-varying excess returns on asset markets

Deviations of national industrial production indexes from trend explain time variation in excess returns on the G7 countries' stock markets. This paper highlights that this finding is driven by a global, common component in the national production gaps. The global component is not a mirror image of the U.S. business cycle. Quite to the contrary, a "rest-ofthe-world" production gap explains time variation in U.S. stock market excess returns while the U.S.-specific production gap does not. However, both U.S.-specific and global gap components explain time-varying excess returns on U.S. bonds. The relative importance of the U.S.-specific risk gap increases with the maturity of bonds.