International Stock Return Predictability: What is the Role of the United States?

We investigate lead-lag relationships among country stock returns and identify a leading role for the United States: lagged U.S. returns significantly predict returns in numerous non-U.S. industrialized countries (after controlling for national economic variables and countries' own lagged returns), while lagged non-U.S. returns display little predictive ability with respect to U.S. returns. The predictive power of lagged U.S. returns is robust across a number of dimensions, including out-of-sample tests. Information frictions seem a ready explanation of the predictive power of lagged U.S. returns; indeed, structural estimation of a news-diffusion model indicates that return shocks emanating in the United States are only fully reflected in equity prices outside of the United States with a lag. Overall, our results indicate that predictive regressions for non-U.S. countries should be augmented with lagged U.S. returns to capture an important source of international return predictability.