Working Paper: NBER ID: w8994
Authors: G. Andrew Karolyi; Ren M. Stulz
Abstract: We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices. International asset pricing models with mean-variance investors predict that an asset's risk premium depends on its covariance with the world market portfolio and, possibly, with exchange rate changes. The existing empirical evidence shows that a country's risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns. However, the theoretical asset pricing literature relying on mean-variance optimizing investors fails in explaining the portfolio holdings of investors, equity flows, and the time-varying properties of correlations across countries. The home bias has the effect of increasing local influences on asset prices, while equity flows and cross-country correlations increase global influences on asset prices.
Keywords: No keywords provided
JEL Codes: G11; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| covariance with the world market portfolio (G15) | risk premium of an asset (G19) |
| exchange rate changes (F31) | expected returns (G17) |
| home bias in investor portfolios (G15) | relevance of international factors in determining domestic stock prices (F30) |
| fluctuations in equity flows (F32) | asset prices in affected countries (F65) |