Are Correlations of Stock Returns Justified by Subsequent Changes in National Outputs?

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  • 1 January 2000
    • preprint
      • Published in RePEc
Abstract
In an integrated world capital market, the same pricing kernel is applicable to all securities. We apply this idea to the stock returns of different countries. We investigate the underlying determinants of cross-country stock return correlations. First, we determine, for a given, measured degree of commonality of country outputs, what should be the degree of correlation of national stock returns. To that end, we develop a model containing a statistical model for output and an intertemporal financial market model for stock returns. We then match the correlations generated by the model with measured correlations. We find that actual correlations can be matched to what they should be in a unified market but that they are much larger than they should be in fully segmented financial markets.

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