This paper tests whether innovations in macroeconomic variables are risks that are rewarded in the stock market. Financial theory suggests that the following macroeconomic variables should systematically affect stock market returns: the spread between long and short interest rates, expected and unexpected inflation, industrial production, and the spread between high- and low-grade bonds. We find that these sources of risk are significantly priced. Furthermore, neither the market portfolio nor aggregate consumption are priced separately. We also find that oil price risk is not separately rewarded in the stock market.

Economic Forces and the Stock Market

We propose a conditional measure of capital market integration that allows us to characterize both the cross-section and time-series of expected returns in developed and emerging markets. Our measure, which arises from a conditional regime-switching model, allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. Our results suggest that a number of emerging markets exhibit time-varying integration. Interestingly, some markets appear to be more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets.

Time-Varying World Market Integration

We propose a measure of capital market integration arising from a conditional regime-switching model. Our measure allows us to describe expected returns in countries that are segmented from world capital markets in one part of the sample and become integrated later in the sample. We find that a number of emerging markets exhibit time-varying integration. Some markets appear more integrated than one might expect based on prior knowledge of investment restrictions. Other markets appear segmented even though foreigners have relatively free access to their capital markets. While there is a perception that world capital markets have become more integrated, our country-specific investigation suggests that this is not always the case.

/pdf/time-varying-world-market-integration-1yjwa14elm.pdf

Time‐Varying World Market Integration

The short-run interdependence of prices and price volatility across three major international stock markets is studied. Daily opening and closing prices of major stock indexes for the Tokyo, London, and New York stock markets are examined. The analysis utilizes the autoregressive conditionally heteroskedastic (ARCH family of statistical models to explore these pricing relationships. Evidence of price volatility spillovers from New York to Tokyo, London to Tokyo, and New, York to London is observed but no price volatility spillover effects in other directions are found for the pre-October 1987 period.

Correlations in Price Changes and Volatility Across International Stock Markets

Value stocks have higher returns than growth stocks in markets around the world. For the period 1975 through 1995, the difference between the average returns on global portfolios of high and low book-to-market stocks is 7.68 percent per year, and value stocks outperform growth stocks in twelve of thirteen major markets. An international capital asset pricing model cannot explain the value premium, but a two-factor model that includes a risk factor for relative distress captures the value premium in international returns.

/pdf/value-versus-growth-the-international-evidence-4tvdunatpz.pdf

Value versus Growth: The International Evidence

This paper investigates the international transmission mechanism of stock market movements by estimating a nine-market vector autoregression (VAR) system. Using simulated responses of the estimated VAR system, we (i) locate all the main channels of interactions among national stock markets, and (ii) trace out the dynamic responses of one market to innovations in another. Generally speaking, a substantial amount of multi-lateral interaction is detected among national stock markets. Innovations in the U.S. are rapidly transmitted to other markets in a clearly recognizable fashion, whereas no single foreign market can significantly explain the U.S. market movements. Also, the dynamic response pattern is found to be generally consistent with the notion of informationally efficient international stock markets.

International Transmission of Stock Market Movements

We examine the contribution of cross-listings to price discovery for a sample of Canadian stocks listed on both the Toronto Stock Exchange (TSE) and a U.S. exchange. We ¢nd that priceson the TSE and U.S. exchange are cointegrated and mutually adjusting. The U.S. share of price discovery ranges from 0.2 percent to 98.2 percent, with an average of 38.1 percent. The U.S. share is directly related to the U.S. share of trading and to the ratio of proportions of informative tradeson the U.S. exchange and the TSE, and inversely related to the ratio of bid-ask spreads. WITH THE ENHANCED GLOBALIZATION of ¢nancial markets, the number of non-U.S. ¢rms cross-listing shares on a U.S. exchange has substantially increased. Attracting non-U.S. listings is now a top priority of the U.S. stock exchanges. At the end of 2000, 420 non-U.S. ¢rmswere listed on the New York Stock Exchange (NYSE).The number of foreign ¢rmslisted on Nasdaq waseven higher.The popularity of international cross-listings has prompted many academic studies on the topic. 1 Most of these studies focus on the bene¢ts of international cross-listings, including the reduced cost of capital and the enhanced liquidity of a ¢rm’s stock. Studiessuch asAlexander, Eun, and Janakiramanan (1987, 1988) and Foerster and Karolyi (1993) suggest that the cost of capital declines because the portion of the risk premium that compensates for cross-border investment barriers dissipates. Miller (1999) and Foerster and Karolyi (1999) propose increased investor recognition as another possible explanation. Several studies examine changes in trading volume and costs due to international cross-listing. Foerster and Karolyi (1998) ¢nd that the bid-ask spreads in Canada decrease after the cross-listing of Canadian stocks in the United States. Domowitz, Glen, and Madhavan (1998) suggest that the impact of cross-listing is complex and depends on the degree of quote transparency, that is, the extent to which price information is observable in the two markets. Smith and So¢anos (1997) examine if cross-listing is a zerosum game, with increased trading in the United States being oiset by reduced

http://www.coba.unr.edu/faculty/liuc/files/RUC/topic_crosslisting/Eun_Sabherwal_2003.pdf

Cross-Border Listings and Price Discovery: Evidence from U.S.-Listed Canadian Stocks

This paper derives a closed-form valuation model in a two-country world in which the domestic investors are constrained to own at most a fraction, δ, of the number of shares outstanding of the foreign firms. When the “δ constraint” is binding, two different prices rule in the foreign securities market, reflecting the premium offered by the domestic investors over the price under no constraints and the discount demanded by the foreign investors. The premium is shown to be a multiple of the discount, the multiple being the ratio of the aggregate risk aversion of the domestic and foreign investors. Given the aggregate risk-aversion parameters, the equilibrium premium and discount are determined by the severity of the δ constraint and the “pure” foreign market risk.

/pdf/a-model-of-international-asset-pricing-with-a-constraint-on-3tuq1jexg3.pdf

A Model of International Asset Pricing with a Constraint on the Foreign Equity Ownership

In this paper, ex ante efficient portfolio selection strategies are developed to realize potential gains from international diversification under flexible exchange rates. It is shown that exchange rate uncertainty is a largely nondiversiflable factor adversely affecting the performance of international portfolios. Therefore, it is essential to effectively control exchange rate volatility. For that purpose, two methods of exchange risk reduction are simultaneously employed: multicurrency diversification and hedging via forward exchange contracts. The empirical findings show that international portfolio selection strategies designed to control both estimation and exchange risks almost consistently outperform the U.S. domestic portfolio in out-of-sample periods. SINCE GRUBEL [11] APPLIED MODERN portfolio theory (MPT) to international investment, various authors, such as Levy and Sarnat [17], Solnik [20], and Lessard [16], have examined the gains from international diversification of investment portfolios. For the purpose of establishing the gains from international diversification, these studies constructed international portfolios using historical risk and return data from a period of fixed or relatively stable exchange rates and showed that internationally diversified portfolios dominated purely domestic portfolios in terms of mean-variance efficiency. From the standpoint of today's investors, however, the previous studies fail to offer operational guidance for international diversification for two important reasons. First, it is now questionable whether the past findings are still relevant under the current flexible exchange rate regime. Second, by being "ex post" in nature, the past studies ignored the issue of estimation risk, or parameter uncertainty, and therefore may have overstated the realizable portion of the potential gains from international diversification. Fluctuating exchange rates are likely to mitigate the potential gains from international diversification by making investment in foreign securities more risky. As will be shown later, a fluctuating exchange rate contributes to the risk of foreign investment not only through its own variance but also through its "positive" covariances with the local stock market returns. During our sample period of 1980 through 1985, for example, exchange rate volatility is found to account for about fifty percent of the volatility of dollar returns from investment in the stock markets of such major countries as Germany, Japan, and the U.K. Furthermore, the exchange rate changes vis-'a-vis the U.S. dollar are found to be

Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection

Segmentation of capital markets produces incentives for firms to adopt countermeasures, one of which is dually listing their stocks on foreign capital markets. In this paper, the behavior of stock returns surrounding such international listings is examined for a sample of firms. Assuming that the capital markets are either completely or “mildly” segmented beforehand, it is hypothesized that the international listing of a security should, in general, accompany a reduction in its expected return. The sample reveals evidence consistent with this hypothesis.

Cheol S. Eun

Papers

International Transmission of Stock Market Movements

Cross-Border Listings and Price Discovery: Evidence from U.S.-Listed Canadian Stocks

A Model of International Asset Pricing with a Constraint on the Foreign Equity Ownership

Exchange Rate Uncertainty, Forward Contracts, and International Portfolio Selection

International Listings and Stock Returns: Some Empirical Evidence