The New Economy and Global Stock Return (Electronic book text)

A longstanding empirical regularity in international equity markets is the low correlation among country portfolio returns. A number of explanations have been advanced to explain this stylized fact. First, instead of diversifying across markets and holding a portfolio that mirrors the global basket of securities, investors exhibit home bias in selecting stocks. If the marginal investor in French stocks lives in France and the marginal investor in U.S. stocks lives in the U.S., with each investor pricing stocks relative to other assets in the home market, country portfolios may in part reflect the different sentiment of French and U.S. investors. Second, country portfolios differ in industrial composition. For example, relative to Switzerland the Swedish stock market contains more firms in basic industries, while the Swiss index has more banks. To the extent that basic industries and banks are imperfectly correlated, the country indices of Sweden and Switzerland will be imperfectly correlated. Third, economic shocks may affect companies differently across countries. This may be because shocks are regional in nature, such as a policy change that is specific to one country. Alternatively national markets may respond differently to global shocks because institutional differences affect the transmission of these shocks to asset values.