On Stock Market Return Co-Movements: Macroeconomic News, Dispersion of Beliefs, and Contagion
57 Pages Posted: 18 Aug 2000
Date Written: June 2000
We document and explain the return co-movement for the U.S., U.K., and Japanese equity markets for the period of 1985-1996. Our empirical results show the importance of imperfect signal-extraction in explaining the equity market return co-movement. In such a setting, domestic investors try to extract the unobservable global factors from foreign market returns and use the extracted information in their subsequent domestic trading. In this imperfect learning environment, domestic investors respond to the foreign return signal more strongly if the signal is more precise. In addition, trading noise may also affect the return-generating process in domestic markets. We find this contagion effect is most pronounced in the extreme down markets.
Keywords: Market co-movement, contagion, signal extraction, macroeconomic news, dispersion of beliefs
JEL Classification: G15, F30
Suggested Citation: Suggested Citation