Origins of International Factor Structures

Abstract

We develop and test a model of the global production and consumption network which connects international co-movements to a simple measure of network closeness. We construct network closeness using observed trade weights in intermediate goods and final consumption goods, and report three findings. (1) Countries that are closer in the network tend to have more correlated consumption growth rates, more correlated stock returns, and more correlated exchange rate movements. (2) International comovements can be decomposed into components driven by primitive shocks and components due to network transmissions. Asset price correlations tend to be explained by the network structure, while consumption correlations by the primitive shock correlations. (3) The trade network generates factor structures in equity returns and exchange rate movements. It explains the existence of the dollar and the carry factors, and gives rise to regional factors. These findings offer a network-based account of the origins of factor structures in international economic quantities and asset prices.