Time-Varying Risk Preferences and Emerging Market Co-Movements

Abstract

This paper examines how shocks can transmit across markets through the channel of time-varying investor risk preferences. We highlight the effects of this channel by comparing the conventional CRRA utility function with the habit-formation utility function of Campbell and Cochrane (1999). Calibrating our model to data from Argentina, Korea and Mexico, we find that in the presence of time-varying investor risk preferences, market integration generates a substantial increase in cross-country co-movements of stock returns.

Keywords: Time-varying risk preferences, habit-formation, emerging market stock returns, correlations and co-movements, financial market integration

JEL Classification: G15, G12, F30