Essays On International Comovements Of Financial Markets
International portfolio diversi…cation is bene…cial only if asset returns are not signi…cantly correlated across countries. Therefore, it is essential for investors who want to make an appropriate portfolio selection to understand the nature of asset return correlations. This thesis consists of three essays on international comovements of …nancial markets. The …rst essay analyzes the e¤ects of heterogeneous beliefs and learning on international comovements of equity returns and portfolio rebalancing mechanism. This essay develops a continuous-time general equilibrium model in a two-asset and two-good economy with two representative agents, who di¤er in perceived rates of output growth and accuracy of beliefs. The equilibrium correlations of equity returns across counties and optimal portfolios are expressed in terms of the di¤erences in beliefs. The main …ndings are: (1) the di¤erences in perceived rates of output growth generate equity home or foreign bias, resulting in lower crosscountry equity return correlations; and (2) the volatilities of optimal portfolios and capital ‡ ows increase with the di¤erences in perceived output growth and with the di¤erences in accuracy of beliefs. The second essay studies the e¤ects of trade costs in goods market on international comovements of equity markets and those on equity home bias. This essay develops a continuous-time general equilibrium model in a two-country, two-asset, and two-good setting where international trade of goods is costly. I solve for the optimal portfolios and the equilibrium correlations of cross-country equity returns and analyze how they change depending on the size of trade costs, the coe¢ cient of risk aversion, and the elasticity of substitution between domestic and foreign goods. It is found that the cross-country equity return correlations decrease with the size of trade costs. This result is robust to di¤erent sizes of trade costs and asymmetry related to potential growth and consumer preferences. It is also found that the size of the trade costs and other parameter values determine whether trade costs would generate equity home bias or foreign bias. The third essay is devoted to an empirical analysis of the e¤ects of …nancial integration on international comovements of …nancial markets. The essay provides a characterization of synchronization among 24 countries over the period 1980-2003. A country-pair panel instrumental variables framework is employed to explain time-varying bilateral correlations among national stock returns, by utilizing the dataset on trade costs in Fitzgerald (2008). It is found that …nancial integration driven by reduction of trade costs leads to a higher degree of synchromization across stock markets.
Prasad, Eswar Shanker
Ph.D. of Economics
Doctor of Philosophy
dissertation or thesis