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.