Is Average Correlation Related to Expected Returns: Evidence From Global Markets

Abstract

We examine whether average country-level stock market correlation is related to global equity returns. Previous research focusing on the U.S. suggests that average firm-level correlation captures some of the risk not accounted for by other variables and is positively related to returns on the broad stock market. In contrast, we find that average country-level correlation does not appear to be related to global returns, and that the Roll (1977) critique is not responsible for this lack of relation. Empirically, average correlation does not help forecast returns.

Keywords: average correlation, forecasting, predictability, Roll critique

JEL Classification: G11, G15