Using a measure of political risk, relative to the United States, that captures unexpected political conditions, we show that political risk is priced in the cross section of currency momentum and contains information beyond other risk factors. Our results are robust after controlling for transaction costs, reversals, and alternative limits to arbitrage. The global political environment affects the profitability of the momentum strategy in the foreign exchange market; investors following such strategies are compensated for the exposure to the global political risk of those currencies they hold, that is, the past winners, and exploit the lower returns of loser portfolios. The risk compensation is mainly justified by the different exposures of foreign currencies in the momentum portfolio to U.S. political shocks, which is the main component of global political risk.

This paper documents the existence of a slowly evolving trend in the log dividend-price ratio, DP t , determined by a demographic variable, MY t : the middle-aged to young ratio. Deviations of DP t from this long-run component explain transitory but persistent fluctuations in stock market returns. The relation between MY t and DP t is a prediction of an overlapping generation model. The joint significance of MY and DP t in long-horizon forecasting regressions for market returns explains the mixed evidence on the ability of DP t to predict stock returns and provide a model-based interpretation of statistical corrections for breaks in the mean of this financial ratio.