The empirical objective of this study is to account for the time-variation
the covariances between markets. Using data on sixteen national stock
markets, we estimate a multivariate factor model in which the volatility of
returns is induced by changing volatility in the orthogonal factors. Excess
returns are assumed to depend both on innovations in observable economic
variables and on unobservable factors. The risk premium on an asset is a
near combination of the risk premia associated with factors.
The main empirical finding is that only a small proportion of the time variation
in the covariances between national stock markets can be accounted
for by observable economic variables. Changes in correlations markets are
given primarily by movements in unobservable variables.
We also estimate the risk premia for each country, and are able to
identify substantial movements in the required return on equity. Our results
also suggest that, although inter-correlations between markets have risen since
the 1987 stock market crash this is not necessarily evidence of a trend
decrease.
*Published:
Econometrica, vol 62, no. 4, (July 1994) pp. 901-933
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