The Long-Term Effect of Globalization on International Stock Return Comovements

Abstract

This paper studies the long-term effect of international trade and financial linkages on the rise in stock return comovements. Our sample covers 47 advanced and emerging markets from 1973 to 2018. We use dynamic panel models that are appropriate for estimating long-term relationships in macro panel data. The results indicate that the rise in comovements among advanced markets is due to trade globalization. Conversely, growing comovements among emerging markets stem from equity market liberalization (i.e., increased foreign holdings of emerging stocks). We thus show that international shareholders can spread shocks across emerging markets, which is a key concern for financial stability and highlights the existence of an international diversification puzzle.