Macroeconomic uncertainty and the excess returns of stock

This paper proposes a theoretical model based on traditional ICAPM and dividend growth models but with variance-belief formation features such as overextrapolation and sticky expectation to link the macroeconomic uncertainty (MU hereafter) and stock excess returns. We predict a nuanced, possibly negative, intertemporal MU-return trade-off and a negative contemporaneous relationship between the change in MU and excess returns. The empirical analysis utilizing panel data from 46 stock markets validates our model but also reveals the heterogeneity across markets with different economic levels, financial development, and national culture. The impact of MU is amplified during global and country-specific financial crises. In addition, we also suggest that MU indeed is a significant source of realized variance of excess returns in stock markets.