Are global systematic risk and country-specific idiosyncratic risk priced in the integrated world markets?

- I estimate time-varying conditional world beta and country-specific risk.
- I consider conditional relationship between global risk and country index returns.
- The conditional world beta risks significantly affect country-level index returns.
- Country-specific risk factors are not significantly priced.
- The results support international financial integration.

Empirical evidence showing significant effects of local factors on international equity returns while failing to find significant effects from global systematic risk seems counter-intuitive in today's integrated world markets. This paper uses the conditional second moments estimated from an asymmetric dynamic conditional correlation model to measure the time-varying world beta and country-specific idiosyncratic risks, and tests the relationship between country-level index returns and world beta risk conditioned on positive and negative world market returns. The results show that the conditional dynamic world beta risks significantly predict the cross-country variation in expected index returns, while country-specific risk is not significantly priced.