Gravity in International Equity Markets
58 Pages Posted: 18 Jan 2019
Date Written: November 15, 2017
The size of economies and geographical distance are signicant determinants of the contemporaneous and cross-serial correlations in international equity market returns across countries. Larger countries lead returns of small-countries, and this cross-country predictability decreases with geographical distance of the two countries. A long-short trading strategy that exploits this relation yields risk-adjusted returns of 10% per annum. The lead-lag relation is not driven by cross-country differences in the average size or liquidity of rms, the degree of stock market development, or the industry composition. Decomposing stock market returns into cash-flow and discount rate news shows that the international transmission of discount-rate news is more pronounced than cash-flow news and that the size of economies and geographical distance are signicant determinants for both components of returns.
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