changes in the comovement of european equity markets this paper investigates the impact that the removal of exchange controls within major european economies has had on the interdependence of european equity markets for five years prior to the removal of exchange controls and five years following their removal we use impulse responses and variance decompositions from vector autoregressions to illustrate that european equity markets have become substantially more integrated after the removal of exchange controls we undertake further tests that demonstrate that even if we allow for parallel macroeconomic harmonization the removal of exchange controls has been a major cause of increased equity market integration within europe

estimating the correlation structure of international share prices recently the case for international portfolio diversification has been convincingly argued in the framework of mean variance portfolio analysis by a number of researchers however virtually no empirical documentation exists concerning the best method for estimating the correlation structure of international share prices in this paper 12 models for estimating the international correlation matrix are presented and empirically tested relative to full historical extrapolation the major evaluation criteria are the mean squared error and stochastic dominance based on the frequency distribution of the squared forecast errors the results indicate that the national mean model strictly dominates all the others in terms of forecasting accuracy in the last fifteen years or so a number of researchers have convincingly argued the case for international portfolio diversification as opposed to purely domestic diversification in the framework of mean variance portfolio analysis see e g grubel 4 levy and sarnat 8 solnik 12 mcdonald 10 lessard 6 and subrahmanyam 15 1 in spite of the emerging consensus in the academic and investment communities that investors can benefit from international diversification in terms of a more efficient risk return tradeoff virtually no empirical documentation exists concerning the best method for estimating the correlation structure of international share prices since estimating this correlation structure is a necessary precondition for being able to apply modern portfolio theory to international investments empirical examination is of major importance moreover only through empirical examination of the correlation structure will the effort to devise a simple algorithm that can be used to solve for the optimal international portfolio be facilitated in order to trace out the set of ex ante efficient international porffolios using the tenets of modern portfolio theory the investor must obtain accurate estimates of the expected return and the variance of return for each domestic and foreign security and he must also obtain accurate estimates of the correlation coefficients of the returns between each pair of securities stated in terms of his numeraire

foreign exchange risk pricing and equity market segmentation in africa abstract this work is the first to investigate simultaneously the occurrence of unconditional currency risk pricing and equity market segmentation in africa s major stock markets the multi factor asset pricing theory provides the theoretical framework for our model we find strong evidence suggesting that africa s equity markets are partially segmented however we find insufficient evidence to reject the hypothesis that foreign exchange risk is not unconditionally priced in africa s stock markets this result is robust to alternative foreign exchange rate adjusted return measures these findings suggest that international investors can diversify into africa s equity markets without worrying about unconditional risks associated with foreign exchange rate fluctuations

global sector rotation new look at an old idea an investment product that capitalizes on the rising importance of the industry factor in increasingly integrated global markets should have a bright future

an empirical investigation of international asset pricing we investigate several asset pricing models in an international setting we use data on a large number of assets traded in the united states japan the united kingdom and france the models together with the hypothesis of capital market integration imply testable restrictions on multivariate regressions relating asset returns to various benchmark portfolios we find that multifactor models tend to outperform single index models in both domestic and international forms especially in their ability to explain seasonality in asset returns we also find that the behavior of the models is affected by changes in the regulatory environment in international markets

arbitrage asset pricing under exchange risk this paper extends the arbitrage pricing theory to an international setting specifying a linear factor return generating model in local currency terms the author shows that the usual risk diversification rule in the arbitrage pricing theory does not yield a riskless portfolio unless currency fluctuations obey the same factor model as asset returns the author then considers an arbitrage portfolio whose exchange risk is hedged by foreign riskless bonds under the resulting no arbitrage conditions the expected returns are not on the same hyperplane unlike the closed economy arbitrage pricing theory unless they are adjusted by the cost of exchange risk hedging copyright 1991 by american finance association

the consumption based asset pricing model a note on potential tests and applications abstract breeden s demonstration that merton s multi beta capital asset pricing model can be collapsed into a single beta model where betas are computed with respect to aggregate consumption is an important theoretical advance nonetheless breeden s model retains many of the empirical problems that beset merton s earlier version in general the consumption betas will be nonstationary so that the state variables must be observable for the model to be estimated

measurement of market integration and arbitrage we develop a measurement theory of market integration based on two notions of integrated markets first two markets cannot be perfectly integrated in any sense if one can construct two portfolios one from each market that have identical payoffs but different prices in that case the law of one price is violated across the markets second they cannot be integrated in a stronger sense if there are cross market arbitrage opportunities two measures of market integration are developed respectively reflecting these notions the smaller the measures the more closely integrated in the respective senses the markets among other things they are interpreted as measuring pricing discrepancy between markets article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

on testing the arbitrage pricing theory inter battery factor analysis this paper tests the arbitrage pricing theory apt by estimating the factor loadings that are consistent between two industry groups of securities one of the pitfalls in the study by roll and ross is that the factors estimated in one group may not be the same with the factors estimated in another group this raises some concerns on the acceptability of their conclusions for our study we employ inter battery factor analysis which enables us to estimate factor loadings by constraining the factors to be the same between two different groups our results show that there seem to be five or six inter group common factors that generate daily returns for two industry groups of securities and these inter group common factors do not seem to depend on the size of groups also based on our cross sectional tests on the risk premia we conclude that the apt should not be rejected the arbitrage pricing theory apt introduced by ross 35 36 provides another model for explaining the relationship between return and risk the apt may be conceived as an alternative to the well known capital asset pricing model capm introduced by sharpe 39 lintner 27 and mossin 29 and later modified by black 1 both models assert that every asset must be compensated only according to its systematic risk one of the major differences is that in the capm the systematic risk of an asset is defined to be the covariability of the asset with the market portfolio whereas in the apt the systematic risks are defined to be the covariability with not only one factor but also possibly with several economic factors another difference is that the capm requires the economy to be in equilibrium whereas the apt requires only that the economy has no arbitrage opportunities note that the absence of arbitrage condition is necessary but not sufficient for the economy to be in equilibrium thus the apt is a more fundamental relationship than the capm in the sense that a rejection of the apt implies the rejection of the capm but not vice versa despite numerous attempts the capm has not been satisfactorily tested and furthermore roll s critique 32 33 casts serious doubts on the testability of the capm itself roll argues that the linear relationship between return and risk will hold for any efficient portfolio thus unless the market portfolio is observed a test of the capm using ex post data is ambiguous it results only in testing the

understanding the greek crisis this paper focuses on the distortions that the greek public debt has imposed on the greek banking system and suggests how these can be unwound the low level of competitiveness of the greek economy which is well below the competitiveness of the developed countries poses a great challenge for the greek banks at the same time it puts at risk greece s economy ability to service both the private and public debt which as an aggregate are comparable to the indebtedness of the developed nations an adjustment of economic activity to match the current low level of competitiveness will increase the risks faced by the financial system and make an orderly servicing of the debt of the economy very challenging it follows that only one reasonable policy option remains to increase the competitiveness of the economy through an aggressive reform agenda so that it will match its level of indebtedness and through the resulting growth shift the excessive debt of the public sector to the private sector

pipeline politics a study of india s proposed cross border gas projects abstract india s energy situation is characterized by increasing energy demand high fossil fuel dependency large import shares and significant portion of population deprived of modern energy services at this juncture natural gas being the cleanest fossil fuel with high efficiency and cost effectiveness is expected to play an important role india with only 0 6 of proven world reserves is not endowed with adequate natural gas domestically nevertheless there are gas reserves in neighbouring regions which gives rise to the prospects of three cross border gas pipeline projects namely iran pakistan india turkmenistan afghanistan pakistan india and myanmar bangladesh india this study is a political analysis of these pipeline projects first it provides justification on use of natural gas and promotion of cross border energy trade then it examines these three pipeline projects and analyses the security concerns role of different actors their positions shifting goals and strategies the study develops scenarios on the basis of changing circumstances and discusses some of the pertinent issues like technology options for underground underwater pipelines and role of private players it also explores impact of india s broader foreign relations and role of saarc on the future of pipelines and proposes energy induced mutually assured protection map as a concept for regional security

a new approach to testing asset pricing models the bilinear paradigm we propose a new approach to estimating and testing asset pricing models in the context of a bilinear paradigm introduced by kruskal 18 this approach is both simple and at the same time quite general as an illustration we apply it to the special case of the arbitrage pricing model where the number of factors is pre specified the data appear to be generally in conflict with a five or seven factor representation of the model used by roll and ross 30 when we consider the number of replications of our test and the large number of observations on which it is performed the frequency with which we reject the three factor apm does not lead us to conclude that this model is unrepresentative of security returns further the rejection of the five and seven factor versions is to be expected if the three factor version is correct the paradigm gives insight into the appropriate specification of the model and suggests that there may be a small number of economy wide factors that affect security returns tests of asset pricing models on the basis of observed stock market data have represented a staple of the financial economics literature of the past twenty years the early work is reviewed in the famous paper by jensen 12 and papers by fama and macbeth 6 rosenberg and marathe 31 and roll and ross 30 there has been a great deal of confusion regarding what testable propositions are implied by these models see discussion in roll 29 in this paper we show that at a minimum all asset pricing models yet proposed imply a simple easily testable hypothesis which we refer to as the bilinear hypothesis while specific models may imply further testable propositions if the bilinear hypothesis is rejected the model is inconsistent with the data and should be rejected our test exploits the fact that the economic content of any equilibrium asset pricing model can be expressed in the form of a potentially refutable constraint on the set of parameters of the process generating security returns this constraint specifies that given a set of security specific characteristics there exists a linear relationship common across securities relating expected returns to these

a critical reexamination of the empirical evidence on the arbitrage pricing theory this paper demonstrates that the roll and ross rr and other previously published tests of the apt are subject to several basic limitations there is a general nonequivalence of factor analyzing small groups of securities and factor analyzing a group of securities sufficiently large for the apt model to hold it is found that as one increases the number of securities the number of factors determined increases this increase in the number of factors with larger groups of securities cannot readily be explained by a distinction between priced and nonpriced risk factors as it is impermissible to carry out tests on whether a given risk factor is priced using factor analytic procedures the apt model as exposited by ross 17 18 and extended by huberman 9 has provided the basis of an extensive literature as for example brown and weinstein 1 chen 3 hughes 10 ingersoll 11 jobson 12 reinganum 15 roll and ross rr 16 and shanken 17 to mention but a few it has also been treated in a more general context by chamberlain and rothschild 2 our purpose here is not to comment on this collection of papers many of which are unpublished but to reexamine the evidence presented by rr and point out major pitfalls involved in the empirical methodology employed by them and others who have followed their lead rr claim that on theoretical and more importantly on empirical grounds arbitrage pricing theory apt is an attractive alternative to the capital asset pricing model capm the apt it is argued requires less stringent and presumably more plausible assumptions is more readily testable since it does not require the measurement of the market portfolio and may be better able to explain the anomalies found in the application of the capm to asset returns the acceptability of the apt like that of the capm or any other theory ultimately depends on its ability to explain the relevant empirical evidence our subsequent discussion will show that many of the prqblems associated with the capm are also present in the apt context and that its ability to explain the relevant empirical evidence is not markedly superior moreover it raises questions not only about the rr and related empirical investigations of the apt but also about the testability of that theory in the present state of the art a major part of the problem results from the necessity to break down the universe being analyzed through the apt model this is forced upon the investigator by the fact

cross holdings estimation issues biases and distortions cross holding occurs when listed corporations own securities issued by other corporations we analyze the effect of cross holdings on market capitalization and return measures as well as implications for econometric testing of asset pricing theories we show that cross holdings generally distort standard market return and risk measures the magnitudes of such distortions are calculated for simulated economies by using a variety of crossholding patterns in addition cross holdings are shown to induce nonstationarity in the covariance matrix of security returns we examine the effect of this nonstationarity for estimating efficient frontiers and factor structures we also discuss the implications for risk return estimates in equilibrium asset pricing models article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

implications of keeping up with the joneses behavior for the equilibrium cross section of stock returns international evidence this paper tests the cross sectional implications of keeping up with the joneses kuj preferences in an international setting when agents have kuj preferences in the presence of undiversifiable nonfinancial wealth both world and domestic risk the idiosyncratic component of domestic wealth are priced and the equilibrium price of risk of the domestic factor is negative we use labor income as a proxy for domestic wealth and find empirical support for these predictions in terms of explaining the cross section of stock returns and the size of the pricing errors the model performs better than alternative international asset pricing models

why common factors in international bond returns are not so common this paper analyzes the common factor structure of us german and japanese government bond returns unlike previous studies we formally take into account the presence of country specific factors when estimating common factors we show that the classical approach of running a principal component analysis on a multi country dataset of bond returns captures both local and common influences and therefore tends to pick too many factors we conclude that us bond returns share only one common factor with german and japanese bond returns this single common factor is associated most notably with changes in the level of domestic term structures we show that accounting for country specific factors improves the performance of domestic and international hedging strategies

international corporate diversification market valuation and size adjusted evidence errunza and senbet es 7 analyze the effects of international operations on the market value of the firm both at theoretical and empirical levels the theoretical model which is largely heuristic exploits the costly supply adjustment of multinational firms mncs in providing international portfolio diversification services to investors who face differential cost barriers to direct holdings of assets across national boundaries mncs compete as financial intermediaries to undo the barriers so that in equilibrium profits are driven out mncs and pure domestic firms sell at an equivalent risk adjusted return however costly financial intermediation and the associated relative efficiency leads to a positive valuation effect for mncs relative to purely domestic firms further the equilibrium analysis implies that demand side investor barriers to international capital flows alone are inconsequential to the valuation of mncs in their pure financial role but that the interaction with the supply side costs are necessary to produce a valuation effect at the corporate level es subject the theory to an empirical analysis in a value based approach by employing a variant of tobin s 17 qratio the analysis controlling for industrial market power suggests that the relationship between the excess valuation and the degree of international involvement doi has magnified over periods characterized by severe u s government controls vis a vis the more recent periods in this paper we formalize the theoretical argument by viewing indirect portfolio diversification by mncs as a means of completing the international capital market we employ a paradigm in the unanimity literature and formally characterize the equilibrium in which there is a rationale for mnc financial intermediation we then perform an expanded empirical study by employing generalized least squares and maximum likelihood procedures since the positive relationship between excess valuation and doi as suggested in es 7 might be attributed to the so called small firm or size and the p e effects the test methodology controls for such effects also the traditional literature has relied upon foreign sales percentage as a proxy for doi in view of the well recognized limitations of this proxy we employ four different measures of international

the effects of international operations on the market value of the firm theory and evidence this paper investigates the existence of monopoly rents associated with international operations in a market value theoretic framework the benefits of international operations evolve from such factors as 1 imperfections in the product and factor markets 2 differential international taxation and 3 imperfections in the financial markets in this paper these factors are subject to an equilibrium analysis in the context of recent advances in financial theory in particular imperfections in the financial sector arising from corporate international diversification are examined in a framework which allows a supply adjustments by multinational firms and b the interaction of barriers to international capital flows faced by both firms and investors taking the u s capital market and investors as a base we then specify the conditions under which the foregoing imperfections get priced out in an equilibrium these pricing effects cannot be detected empirically through the methodologies employed by the existing studies which examine the effects of corporate international diversification indeed it was an attempt to rescue the limitations of these studies which initially motivated our paper the existing empirical inquiries into this area rely on traditional risk adjusted performance measures e g 7 or international analogs of return generating processes e g 1 8 instead at the empirical level we employ a value based method which is in the same vein of the thomadakis 17 approach developed to identify the monopoly benefits of industrial market structure we conduct the tests over subperiods characterized by differential government controls in an attempt a to separate the pure financial motives for multinationality from other motives and b to detect if the benefits of international operations carry through recent periods

student t distribution based var mgarch an application of the dcc model on international portfolio risk management significant second moment transmission effects and obvious time varying patterns of correlation coefficients among major equity and currency markets in the us japan and the uk are found to exist such observations inspire the time varying setting of dynamic conditional correlation coefficients in mgarch models on the other hand the multivariate student t distribution is suitable for analysing the visible leptokurtosis that is common in financial markets both are important for international portfolio risk management thus a comparison on the hedging efficiency of hypothetical portfolios consisting of stock and currency future positions is conducted in order to justify the multivariate student t distribution based on the dcc mgarch model

stock returns and the transfer of information between the new york and tokyo stock exchanges abstract this study examines the transmission of pricing information between the new york nyse and tokyo tse stock exchanges using opening and closing stock prices for seven japanese firms the results of this study suggest that 1 sample firm tse opening returns respond to changes in sample firm nyse intraday stock performance with transmission apparently completed at the tse opening and 2 sample firm nyse opening returns as well as subsequent trading respond to changes in sample firm tse intraday stock performance taken together the evidence reported in this study is generally consistent with the notion of semi strong form market efficiency jel g15

common volatility in international equity markets in this article we take advantage of the time varying structure of stock returns variances to investigate whether two international stock markets share the same volatility process we use a test recently developed by engle and kozicki this test is also used to assess the validity of a one factor autoregressive conditional heteroscedasticity model we find that some international stock markets have the same time varying volatility

swaps expectations and exchange rates abstract this paper explores the influence of expectations of a significant subset of the foreign exchange market viz the u s commercial banks on foreign exchange rates for this purpose conventional swap transaction was utilized in a refined framework to enable more accurate extraction of the u s commercial banks expectations from their observed behavior statistical results suggest that although riskless arbitrage opportunities were fully exploited in this market the group under observation either influenced the pound sterling exchange rates in a significant manner or had superior market timing skills

an empirical comparison of alternative models of capital asset pricing in germany abstract in an empirical investigation this research finds that the capm is a better explanatory model of risk return relationships in the german stock market than the ccapm

barriers to portfolio investments in emerging stock markets the authors examine to what extent features of the international tax system and indicators of transaction costs affect the required rates of return on emerging stock markets they show that the capital gains withholding tax levied on foreign portfolio investors increases required pre tax rates of return as countries generally do not index their capital gains taxes it follows that inflation increases the capital gains tax base as well as the required rate of return on equity dividend withholding taxes instead appear not to increase the required pre tax equity returns significantly the differing results for capital gains and dividend taxes reflect the fact that foreign investors generally can receive domestic tax credits only for foreign withholding taxes paid on dividends the return on equity is part of the issuing firm s cost of capital so capital gains withholding taxes imposed on nonresidents increase the cost of capital for domestic firms and discourage physical investment private investment levels have tended to be low in developing countries in the 1980 s the cost of equity finance in developing countries has gained in importance in the last decade as these countries access to international lending capital has been limited during most of the decade what do these findings imply for the design of tax policy in relation to foreign portfolio investment in developing countries the existence of foreign tax credits for dividend taxes paid suggest that a country should tax capital gains more lightly than repatriated dividends as do greece pakistan portugal and venezuela each of these countries has positive dividend withholding taxes but no capital gains taxes imposed on non residents colombia and india do the exact opposite they tax capital gains far more heavily than dividends despite what appears optimal the trend in developing countries is toward lower dividend withholding taxes with little change in the average level of capital gains taxation it appears desirable for developing countries to index their capital gains taxes to prevent them from being higher than anticipated

international arbitrage pricing theory an empirical investigation in this paper we test the arbitrage pricing theory apt in an international setting inter battery factor analysis is used to estimate the international common factors and the chow test is used in testing the validity of the apt our inter battery factor analysis results show that the number of common factors between a pair of countries ranges from one to five and our cross sectional test results lead us to reject the joint hypothesis that the international capital market is integrated and that the apt is internationally valid our results however do not rule out the possibility that the apt holds locally or regionally in segmented capital markets finally the basic results of both the inter battery factor analysis and the cross sectional tests are largely invariant to the nume raire currency chosen numerous authors notably solnik 21 grauer litzenberger and stehle 11 and stulz 24 have derived various versions of the international asset pricing model iapm under alternative views of the structure of international capital markets however only a few serious attempts have been made to test various versions of the iapm these tests are largely inconclusive see solnik 20 and stehle 23 apart from the problem stressed by roll 16 of identifying the world market portfolio previous tests of the iapms suffer from the technical problem of aggregating assets of national investors using different numeraire currencies differences in the numeraire arise from differences in consumption baskets in an environment characterized by exchange rate uncertainty in a fruitful attempt to extend the arbitrage pricing theory apt of ross 18 to an international setting solnik 22 derives an international arbitrage pricing theory which is largely devoid of the aforementioned difficulties and thus more amenable to empirical testing 1 as shown by solnik testability of the apt in an

yes the apt is testable the arbitrage pricing theory apt has been proposed as an alternative to the meanvariance capital asset pricing model capm this paper considers the testability of the apt and points out the irrelevance for testing of the approximation error we refute shanken s objections including his assertion that roll s critique of the capm is applicable to the apt we also explain the testability of the apt on subsets and we explore the relationship between the apt and the capm the arbitrage pricing theory apt has been the subject of extensive research efforts since it was introduced by ross 36 37 the research has included theoretical papers and a growing empirical literature 2 nonetheless there seems to be some confusion in the literature about the relation between the theoretical underpinnings of the apt and its empirical tests this paper is an attempt to alleviate the confusion to illustrate the issues and to provide a focus section i of this paper is devoted to examining and refuting some points raised in shanken 40 which considers the testability of the apt the underlying premise of the apt is that asset returns ri are generated by a factor model of the form

general factor models and the structure of security returns based on markowitz s pioneering study 40 sharpe 56 and lintner 38 advanced the first positivist formulations of the capital asset pricing model capm their models were subsequently refined by mossin 45 fama 15 black 1 and others even though the capm has been studied extensively it has not been empirically validated according to roll 48 the capm cannot be tested in an unambiguous fashion because of a number of intractable measurement and computational difficulties and the joint nature of the hypotheses to be tested

capital controls and international capital market segmentation the evidence from the japanese and american stock markets the paper focuses on two countries japan and the u s to test the integration of capital markets in japan the enactment of the foreign exchange and foreign trade control law in december of 1980 amounted to a true regime switch that virtually eliminated capital controls using multifactor asset pricing models we show that the price of risk in the u s and japanese stock markets was different before but not after the liberalization this evidence supports the view that governments are the source of international capital market segmentation the notion that world capital markets are perfectly integrated is central to most theoretical developments in both international finance and macroeconomics indeed it also lies behind much of the recent international policy discussion capital markets are integrated if assets with perfectly correlated rates of return have the same price regardless of the location in which they are traded 1 segmentation may arise either because of government impediments to capital movements or because of individuals attitudes or irrationality if the hypothesis that the international capital markets are integrated is rejected there is still an important empirical question left unanswered which is related to the source of segmentation while there is a rich body of theoretical research on international market integration only a few studies have tried to investigate this important question empirically a first group of empirical studies on market integration has generally adopted

the origins of financial openness a study of current and capital account liberalization theory we assess the determinants of the national regulation of international finance or the comparative degree of national financial openness or closure hypotheses partisanship interacts with a nation s factor endowments to account in part for different international financial policies by governments of the same partisan hue methods we offer a quantitative measure of international financial openness or current and capital account regulation for 21 member countries of the organization for economic cooperation and development for 1950 88 we use regression analysis employing panel corrected standard errors to discover the determinants of financial openness results our main finding is that political partisanship substantially explains openness but does so in complex ways differences in both political institutional arrangements and types of political economy also account for part of the differences in international financial regulation

why empirical international portfolio models fail evidence that model misspecification creates home asset bias abstract international portfolio models consistently predict that investors should put much more of their wealth into foreign assets than they actually do a result known as home asset bias we use actual international portfolio data to show how model misspecification contributes to this bias we find that three widely used simplifying assumptions produce optimal portfolio weights that are significantly different from the weights produced by an unsimplified model in particular imposing the invalid assumption that ppp holds exaggerates the degree of home asset bias these findings suggest that researchers should pay greater attention to empirical model specification in the future