# **1 Introduction**

The international synchronization of asset prices has attracted increasing attention in recent years. From the macroeconomic perspective, it represents a mechanism for the cross-country propagation of shocks, a matter of concern especially after the global financial crisis. From the finance perspective, it detracts from the presumed benefits of international portfolio diversification. Asset price synchronization has been on a rising trend, especially in the case of equity markets. Christoffersen, Errunza, Jacobs, and Langlois (2012) find that international dependence between stock markets has trended significantly upward since the 1970s, for both advanced and emerging countries. Jorda, Schularick, Taylor and Ward (2017), using data for 17 advanced countries spanning 150 years, find a marked long-run rise in the degree of international comovement of equity prices, above and beyond the comovement of the prices of other assets such as housing and debt. Using the same data, Bekaert and Mehl (2017) similarly find an increase in the conditional betas averaged across countries, in both value-weighted and unweighted terms. In turn, Cotter, Gabriel and Roll (2018) conclude that common global factors account for an increasing share of the variance of equity, bond and real estate returns across developed and emerging markets.

Much of the empirical literature attributes the international dependence of asset prices to pervasive shocks affecting a multitude of countries. A number of recent contributions view the shocks as reflecting a global financial cycle driven primarily by – shifts in international investors’ risk aversion as well as monetary policy in center countries, notably the U.S. (see e.g., Rey (2013), Miranda-Agrippino and Rey (2018), Bruno and Shin (2015), Xu (2017)).<sup>1</sup> Empirically, the shocks driving asset prices across the world are typically modeled as latent common factors or, alternatively, summarized by a handful of variables capturing global financial conditions. This literature goes on to assess the determinants of countries’ exposure to the global financial cycle, with particular attention to the insulating role of flexible exchange rates; see for example Rey (2013) and Bekaert and Mehl (2017).

Another strand of empirical literature has attributed the international comovement of asset prices to real and financial linkages between countries.<sup>2</sup> Bayoumi, Fazio and MacDonald (2007) show that bilateral geographic distance can account for much of the observed variation in the pairwise correlation of equity price indices across a sample of emerging markets.<sup>3</sup> Forbes and Chinn (2004) assess how trade and financial linkages between five center countries and 40 other countries shape the response of the latter countries’ equity market returns to those of the former, concluding that bilateral trade plays the biggest role. Didier, Love and Martinez-Peria (2012) examine the

> 1Similarly, Forbes and Warnock (2012) stress the role of global investors’ risk aversion for the international comovement of capital flows, while Barrot and Serv ́en (2018) and Cerutti, Claessens and Rose (2017) evaluate the quantitative relevance of the global financial cycle for the observed patterns of flows.

> 2In a similar vein, several papers have highlighted the role of bilateral linkages in the international propagation of sovereign and banking crises. Bolton and Jeanne (2011) stress banks’ holdings of foreign sovereign debt as a key mechanism in the propagation of the Eurozone crisis. Hale, Kapan and Minoiu (2016) likewise document how interbank loans help transmit distress across national banking systems.

> 3Chong, Wong, and Zhang (2011) likewise relate the pairwise correlations across a sample of advanced and emerging countries to bilateral distance plus other gravity variables, and find that distance has a robust negative

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