Economic policy uncertainty in OFDI host countries and the cross-section of stock returns

Abstract

This study examines the association between foreign economic policy uncertainty (FEPU) originating from the host countries (regions) of outward foreign direct investment (OFDI) and expected stock returns. We construct a novel variable, FEPU, based on the year-end OFDI amounts of Chinese listed multinational enterprises (MNEs) and the EPU indices of 23 host countries (regions). Our findings reveal that stocks with higher FEPU outperform those with lower FEPU by 4.96 % annually. Beyond predicting short-term expected returns, FEPU also exhibits strong positive predictive power for firms’ long-term cumulative returns. Additionally, through mechanism tests, we demonstrate that this excess return is attributable to compensation for risk premium. Unlike the majority of studies that focus solely on the impact of EPU within a single country or region, we examine the cross-border implications of EPU. This approach offers an innovative perspective on the pricing of MNEs’ stocks by characterizing the exposure to external EPU.