Why Does Stock Market Volatility Differ across Countries? Evidence from Thirty Seven International Markets

ABSTRACT There are substantial differences in stock market volatility across countries. This paper asks why market volatility differs across countries. Using Datastream Country Indexes covering thirty seven international markets, this paper finds that the education level of investors plays a significant role in explaining cross-country market volatility differences. In addition, there is some evidence indicating that market industry concentration, the relative size of the stock market, and the number of firms listed may also be of significant explanatory power to cross-sectional market volatility differences. These findings can help predict international market volatility. JEL: G15, E44 Keywords: Stock market volatility; International stock markets; Determinants of market volatility I. INTRODUCTION Dramatic volatility differences across international stock markets have been observed (see, for instance, Roll (1992), Harvey (1995a), Bekaert and Harvey (1997), and Aggarwal, Inclan, and Leal (1999)). However, the reason why market volatility differs across countries remains unclear. Cohen, et al. (1976), using data from three markets, the U.S., the U.K. and Japan, provide evidence that differences in returns variance across the exchanges are largely explained by differences in market thinness and share turnover. Grinold, Rudd, and Stefek (1989) find that both industry and country explain part of the typical stock's return behavior. Roll (1992) compares 24 equity price indexes and claims that countries' industrial structure explains approximately 40% of volatility differences among markets. However, Heston and Rouwenhorst (1994) and Griffin and Karolyi (1998) find that market industry composition can explain little of the variation in country index returns. The purpose of this paper is to provide some new insights into the question of why market volatility differs across countries. This question is important because, by answering this question, we may be able to identify critical factors that drive market volatility, which is a key element of modern finance theory. To investigate this question, we use a new, large database, Datastream Country Indexes. This database includes thirty seven countries, covers the period from 1973 through 2000, and contains observations from both developed and emerging markets in a nearly balanced manner. Using such a large database, we hope that the sample size limitation typically shared by previous studies can be avoided and, consequently, sample selection bias can be nearly eliminated. Our major findings are as follows. The average education level of investors in a market, proxied by school life expectancy in a country, is significantly and negatively related to market volatility across countries. We interpret this result as evidence supporting the notion that the collective characteristics of investors in a market play a significant role in shaping market volatility. Market industry concentration, proxied by a Herfindahl variable, may also be a significant factor in explaining volatility differences across markets. Specifically, we find a significant, positive relationship between market industry concentration and market volatility. This finding is consistent with that of Roll (1992). The relative market size, which is measured by the ratio of total market capitalization over gross domestic production (GDP) in a country, is negatively associated with cross-sectional market volatility. Smaller stock markets are more volatile. This result confirms Bekaert and Harvey's (1997) conjecture. A weak, negative relationship between the number of listed firms and market volatility is also found. The remainder of the paper is separated into five sections. Section II describes the sample. Section III provides details about how we measure market volatility. Section IV describes potential factors that may affect market volatility. Section V contains empirical results. …