The Comovement of US and UK Stock Markets

Authors


  • We would like to thank Jesper Rangvid, seminar participants at Stockholm School of Economics and University of Basel, and participants at the Arne Ryde Workshop in Empirical Finance in Lund, the Centre for Analytical Finance Annual Meeting at Sandbjerg Manor, the Second T.N. Thiele Symposium on Financial Econometrics in Copenhagen, and the 31st Meeting of the European Working Group on Financial Modelling at Cyprus, for useful comments to earlier versions of this paper. We also thank Dirk Nitzsche for supplying part of the UK data used in the paper. Of course the usual disclaimer applies.

Abstract

US and UK stock returns are highly positively correlated over the period 1918–99. Using VAR-based variance decompositions, we investigate the nature of this comovement. Excess return innovations are decomposed into news about future dividends, real interest rates, and excess returns. We find that the latter news component is the most important in explaining stock return volatility in both the USA and the UK and that stock return news is highly correlated across countries. This is evidence against Beltratti and Shiller's (1993) finding that the comovement of US and UK stock markets can be explained in terms of a simple present value model. We interpret the comovement as indicating that equity premia in the two countries are hit by common real shocks.

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