By Sudip Kar-Gupta
PARIS (Reuters) - Growing uncertainty over this year's French presidential election is starting to have an impact in terms of how risky the country's stock market is perceived by investors.
The jitters have not only begun to play on nerves in the French bond market but are also creeping through to French stocks, as measured by the country's equity risk premium (ERP).
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The ERP is the extra return investors expect from a combination of dividend yields and earnings-driven stock price projections, compared with yields on low-risk government bonds minus inflation.
While a relatively elevated ERP reading can signify that a market may offer higher returns than others, it can also indicate that investors are more wary of investing in that market compared to others.
France's ERP has risen steadily in January, as previous forecasts of victory for the business-friendly, conservative candidate Francois Fillon have been hit by allegations that his wife was paid for work she may not have done. Fillon has denied any wrongdoing.
The reading dropped down in November and December, when Fillon was regularly coming out on top in the polls. However, it has then climbed back up at the start of 2017 to just shy of seven percent.
Investors also fear the possibility of a win for Marine Le Pen, leader of the far-right National Front (FN), with French borrowing costs rising this week.
"It reflects the increasing polarization of the election, namely the growing political and event risk," said Phoebus Theologites, co-founder of multi-investment company SteppenWolf Capital.
"Not only has a far-left candidate won the primary for the Left despite wide expectations of a more moderate candidate coming through, but the far-right candidate has announced that she will table a bill for France to leave the euro, if elected," he added.
Fillon is under pressure to withdraw his candidacy, while left-wing Socialist candidate Benoit Hamon and Le Pen have started to gain more ground in the polls - unsettling investors.
France's CAC-40 equity index <.FCHI> has also underperformed at the start of 2017, even though many of its blue-chip companies do much of their business outside France, and would therefore be insulated to an extent from Parisian politics.
The CAC is down around 1 percent so far in 2017, compared to a 0.3 percent rise on the pan-European STOXX 600 index <.STOXX>.
"The likely withdrawal of Mr Fillon from the presidential race not only eliminates a pragmatic pro-business candidate but also puts the whole traditional right in disarray and thus in a dismal position to face the election," said Roberto Magnatantini, head of global equities at SYZ Asset Management.
"The most obvious beneficiaries are the candidates and parties that vocally contest the status quo, led by Marine Le Pen. Their economic agendas are worrying enough to probably explain an increase in France's risk premium."
(Editing by Leigh Thomas; Editing by Tom Heneghan)