Sources of cross-sectional variations in stock returns and risk: an empirical analysis of emerging markets
It is well established in the financial economics literature that potential gains frominternational diversification are generated from the imperfect correlation betweennational stock market returns. This empirical study explores the factors that impedeperfect integration among national equity markets by examining emerging marketsdata.The first major topic of the dissertation is to re-visit the debate on the relativeimportance of country and industry effects in the cross-sectional variation of stockreturns. By applying the standard Heston and Rouwenhorst (1994) dummy variabledecomposition method to $U. S. nominal returns from 11 industry sectors of 13emerging markets from 1984 to 2004, this work confirms that country effects do playa dominant role in determining the cross-sectional variation in stock returns inemerging markets but since late 1990s, the industry effects have become increasinglyimportant. This conclusion is robust even after the removal of three potential biases:inflation rate, exchange rate and interest rate effects, all of which may amplify thecountry effects.The second topic is to investigate the debate from the perspective of stock risk. Stockrisk is modeled and calculated independently from a return model with ARCH typeerrors. By applying the standard dummy variable decomposition method to stock risks,the empirical evidence is found to support the conclusions drawn on stock returndecompositions.Finally, in order to find the fundamental sources of the country and industry factors,pure country and industry effects are then regressed on fundamental characteristics ofcountry and industry. The findings show that the change in the variables representingthe exchange rate can explain a substantial amount of the country effect variations,while at the same time, banking and stock markets development also contribute to thevariations. The regressions also find evidence that the legal origin of the market doesmatter to stock returns. Regressions on industry effects are not as promising as theresults of the country effects regression. Only the geographical concentration ofindustries is found to explain a small amount of the industry effects.
Year of publication: |
2007
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Authors: | Bai, Ye |
Publisher: |
Ye Bai |
Subject: | Diversification | Country and industry effects | Cross-sectional stock return variation | Emerging markets | Financial development | Legal system | Firm characteristics |
Saved in:
freely available
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