Measuring capital market integration

Transcription

1 Measung capal make negaon Mana Ems, 1 Naonal Bank of Belgum Absac The convegence of Euopean economes n he wake of Euopean moneay unon, ogehe wh nceasngly common dynamcs n cuency and equy euns, suggess ha capal makes ae a leas paally negaed. We mpose a dynamc faco analycal model fo he euns on cuency and sock pofolos on egh Euopean makes, akng no accoun pedcably by fowad pema and dvdend yelds. The esulng asse pcng model s chaacesed by me-vayng sk pema, and consan beas and eun vaances. We popose a measue of he degee of negaon and examne s evoluon fom 1979 unl We fnd ha he degee of negaon fo equy makes nceased n he 1990s bu ha hs was manly due o an ncease n he pemum fo exa-euopean cuency sk. We also fnd ha he souces of co-movemen le only n pa n he US equy makes. 1. Inoducon Ths pape sudes he exen o whch capal makes n Euope ae negaed. If makes ae compleely negaed, asses possessng he same sk chaacescs wll have he same pce even f hey ae aded on dffeen makes. In compleely negaed capal makes, nvesos face common and couny-specfc o dosyncac sk, bu pce (dencally n all makes) only common sk facos, because couny-specfc sk s fully dvesfable. When makes ae paally negaed, nvesos face boh common and dosyncac sks and pce hem boh. If makes ae compleely segmened, nvesos face and pce only couny-specfc souces of sk. In hs case, he same pojecs n wo counes can have dffeen expeced euns, snce he souces of sk and he pces may dffe acoss makes. One way o measue he degee of fnancal negaon s o sudy he effec of legal baes and axes on capal flows o pces, 3 such as escons on foegn sock owneshp and egulaons on muual funds' nvesmens. Ths appoach suffes fom he dsadvanage ha, on he one hand, no all counes mpose he same fomal escons on capal flows, and on he ohe hand, nvesos fnd ways o ccumven legal baes o abage, so ha coss-couny compasons and he effecve nensy of segmenaon become dffcul o measue. Anohe appoach s o es whehe makes ae negaed by assumng an asse pcng model. Unde he assumpon of fully negaed capal makes, he pce of an asse wll depend on s covaance o bea wh he eun on a mean vaance effcen benchmak pofolo. Ths appoach has been used exensvely o sudy wold capal make negaon: fo example by Havey (1989, 1991) and De Sans and Gead (1997) hough a wold CAPM; by Feson and Havey (1993, 1994) hough a mulple sk obsevable faco model; and by Adle and Dumas (1983), Sulz (1981, 1998), Dumas and Solnk (1995), Dumas (1994) and De Sans e al (1998) hough a wold CAPM wh cuency sk and a consumpon-based model. Tesng negaon n hs famewok enals esng he 1 3 NBB Reseach Depamen, e-mal: mana.ems@nbb.be. I am gaeful o Luceza Rechln, Joge Rodgues and Bas Weke fo helpful suggesons and commens. All eos ae mne. The vews expessed ae hose of he auho. See, fo example, Poes and Rey (1999) and Lemmen and Ejffnge (1995). Moe ecenly, Bekae and Havey (1995) have used capal flows ogehe wh ohe macoeconomc vaables o dae negaon n wold makes. Fo example, Heala (1989) and Baley and Jagan (1994) sudy he pce dffeenal beween esced and unesced shaes ha have dencal payoffs, and Bonse-Neal e al (1990) sudy he dffeences beween offcal and black make exchange aes, beween offcal and offshoe nees aes, o beween he make pce and he ne asse value of closed end muual funds. 00 BIS Papes No 1

2 pcng escon mposed on all he asses by he model. Theefoe, f he benchmak pofolo s msspecfed, n he sense ha does no capue all sysemac souces of sk, he es wll ejec he negaon hypohess ncoecly. In ode o cual hs poblem, s possble o consde ha, even hough he benchmak pofolo s unobsevable, he covaance max of he asse euns follows a laen faco sucue. Abage pcng heoy (APT) ells us ha, as long as he laen sk facos ae coecly denfed, asses can be pced accuaely hough he covaance wh he facos. In hs case, denfcaon of he sysemac souces of sk s, fom a sascal pon of vew, moe complcaed, n he sense ha one needs o make assumpons on he sascal popees of he daa geneang pocess fo euns. Such assumpons ae made on he condonal mean of euns (Campbell and Hamao (199), Bekae and Hodck (199)), he condonal vaance of euns o he condonal vaance of he facos, such as he faco-arch model used by Engle e al (1990) and many ohes moe ecenly, such as Feson and Havey (1999). The APT povdes us wh a pcng escon ha can be esed o used o ascean he valdy of he faco model. In he famewok of an nenaonal APT, hs s he appoach followed by Kng e al (1994) and Senana e al (1999) o sudy he souces of me vaaon n he coelaons beween make euns and he effecs of EMU on he cos of capal. In hs pape, we use a K-laen dynamc faco model wh consan beas and consan condonal second momens fo cuency and sock euns on egh Euopean makes. A dynamc faco appoach s needed n ode o capue he pedcably of monhly euns. 4 In pacula, he asse pcng model s dynamc n he sense ha condonal expeced euns vay hough me because common faco sk pema ae me-vayng. 5 Fuhemoe, because an nveso would pce only sysemac souces of sk, he model fo euns should be able o dsngush beween hs ype of sk and dosyncac o dvesfable sk. Theefoe, I adop he dynamc faco model poposed by Fon and Rechln (1998). Ths model mposes euns o be pedcable, he souce of pedcably and co-movemen beng Euopean common shocks ha popagae acoss makes and counes and geneae he obseved co-movemen of euns. In fully negaed makes, hese common shocks also consue sysemac o undvesfable busness cycle sks, as opposed o dosyncac o couny-specfc souces of sk whch a Euopean nveso can compleely dvesfy away by nvesng n he dffeen makes. Ths pape evaluaes he exen o whch he souce of common sk valued by nvesos n Euopean makes s macoeconomc flucuaons, n conas o fnancal ones, and nvesgaes whehe he souce les n Euope o splls ove fom he US economy and fnancal makes. Havng mposed he dynamc faco model on he se of asse euns n dffeen Euopean counes, we ae able o exac he common componen. Ths s, by consucon, he pa of each make s expeced asse eun ha s spanned by he same sysemac sk pema and s used o nvesgae he followng quesons concenng he souces of he common shocks: Wha ae he souces of common flucuaons n sock euns Have he aggegae cuency and make sk pema nceased Does he souce of EU-wde make sk le n US o home oupu Fuhemoe, ae Euopean fnancal common componens manly due o splloves fom he US sock makes The ogansaon of hs pape s as follows. Secon 1 pesens he dynamc faco model, whch we mpose on euns on cuency and sock pofolos acoss Euopean makes. Secon descbes he asse pcng model and uses a no abage oppounes agumen o show ha asse euns wll follow a one-faco model unde he hypohess ha capal makes ae pefecly negaed. Secon 3 pesens he esmaon mehodology and he measue of he degee of negaon. Secon 4 pesens he empcal applcaon and he esuls. Secon 5 summases and concludes. 4 5 Fo he Uned Saes, see Fama and Fench (199), Fama (1990) and Bekae and Hodck (199); see also Campbell and Hamao (199) fo nenaonal cuency and sock euns and Canova and DeNcolo (1997) fo cuency and bond euns n Euope. In a geneal equlbum model, common faco sk pema would eflec he pce of sk assocaed wh he busness cycle. BIS Papes No 1 01

3 . The condonal faco model fo euns The sang pon fo he analyss s a dynamc faco model fo euns, based on he dynamc faco analycal model poposed by Fon and Rechln (1998). Assume a wold wh a lage numbe of counes, = 1...N. Fo each couny, consde he euns on wo ypes of pofolos: a cuency pofolo wh excess eun c, and a sock pofolo wh eun. Sock euns ae expessed n home cuency, n excess of he euocuency ae fo a one-monh nvesmen on he London make. Cuency euns ae consdeed fo a coveed nvesmen n USD and, unde nees ae pay, we have ha cuency euns ae cuency pces n excess of he pevous monh fowad ae. Consde also dvdend yelds, dy, and fowad pema, ( j) of sze equal o J = 4, conanng he sacked, j c,, dy fp sucue: K Ck L uk A, 1... N k 1 fp. Le us assume ha he veco eun pocess,, has he followng dynamc faco, K < NJ s he dmenson of he faco model. Of couse, we can we equaon (1) fo each vaable sepaaely, bu fo wha we wll need fuhe on, we wll jus pesen he wo equaons concenng euns: (1) K c c k 1 C ck ( c) ( c) ( c) L u A A k () K k 1 C k ( ) ( ) ( ) L u A A k whee j ae he uncondonal means of he vaables, u k, k 1... K ae K shocks o sysemac sk facos, common o all Euopean capal makes and economes, A ( j ) ae couny- and vaable-specfc o dosyncac componens assocaed wh cuency, sock euns, dvdend yelds and fowad pema n each couny especvely, C L jk ae nfne ode lag polynomals n he lag opeao L and ( j ) wll be called he common componens. The common shocks ae uncoelaed wh each ohe conempoaneously and a all leads and lags, and uncoelaed wh all dosyncac vaables. In pacula, fo E 1, nong he condonal expecaon wh espec o he nfomaon se, he followng assumpons ae made: 1. The common shocks u k k 1... K A ( j ), ae zeo mean vaables, muually uncoelaed and ohogonal a all leads and lags, e E 1u k 0 fo k 1... K and E 1A 0, E u u 0 fo k, l 1... K, E u A 0 fo k 1... K 1 k l whch, n un, mples:, and he dosyncac componens, 1 k E 1u luk s 0 fo s 1,..., and E 1u k A s 0 fo k 1... K, s 1,... 1 k 1 k E u Eu I fo k 1 K : he common shocks have consan condonal vaances. ( j ) 3. E A F, j 1 : he dosyncac em also has consan and fne condonal vaance. Fuhemoe, as n Fon and Rechln (1998), s assumed ha he dosyncac componens ae muually ohogonal, alhough hey could be auocoelaed. The model allows fo coss secon and me sees heeogeney, snce he degee of he lag polynomals may dffe acoss counes. Usng a law of lage numbes agumen, Fon and Rechln (3) 0 BIS Papes No 1

4 (1998) show ha as he coss secon becomes asympocally lage, because of he ohogonaly popey of he dosyncac componens, he dosyncac componen vanshes when we fom K aggegaes of he vaables. 6 Ths means ha he K aggegaes, fomed by akng lnea combnaons of he vaables, wll span he space of he common shocks and ha we can use hem o denfy he numbe of common shocks, ecove he common componen and also esmae he faco sk pema. Ths faco model fo he asse euns s obsevaonally equvalen o he geneal K-faco model wh me-vayng condonal mean fo euns and consan second momens used n he fnancal leaue by, fo example, Fama (1990), Campbell and Hamao (199) and Bekae and Hodck (199). To see hs, noe ha equaon (1) can be ewen n he followng way: E wh E 1 1 K k 1 C k 0 K k1 u C k k A L u E k1 1 D (4) whee E 1 s he veco of he condonal mean euns on he cuency and sock pofolos o, n ohe ems, he sk pema fo he pofolos n couny and D s he coespondng unancpaed (a -1) componen fo euns. Noce ha he nfomaon se I 1 also conans he pas of dvdend yelds and fowad pema. The usual faco epesenaon fo he covaance sucue of euns s he followng: E K 1 > kfk A (5) k 1 The facos, f k, ae muually ohogonal and uncoelaed wh he dosyncac em A, and he menvaan bea coeffcens > k measue he sensvy of each asse o he common souces of sk. In he geneal case, he sascal model fo euns does no explcly esc he condonal mean o depend on he facos. An asse pcng escon obaned hough an economc model such as a paal equlbum consumpon model, o hough a model-fee assumpon, such as a no abage oppounes agumen, wll lnk he condonal mean of euns o me-vayng faco sk pema. Fuhemoe, all me vaaon n he sk pces s assumed o be capued by a few sae vaables n he nfomaon se. The dynamc faco model mposes ha he sae vaables n he economy and he asse euns span he same space, whch n un s spanned by he common shocks. The condonal mean of he euns depends fo hs eason on he facos hemselves and he beas measue no only he sensvy of ndvdual asse euns o he dffeen souces of sk, bu also he delay n popagaon of he shocks n each make and couny. Equaons () and (3) decompose euns no wo componens. The fs,, s spanned by he pesen and pas of he common shocks o sk facos and he second, A, s couny- and vaablespecfc. Equaons (4) and (5) decompose he unancpaed componen of euns no wo pas: he fs depends on he cuen ealsaon of he common shocks bu dffes acoss counes dependng on he sensvy of each vaable n each make wh espec o he sk unde consdeaon; he second s he dosyncac componen and, unde he assumpons, s dvesfable. Noe ha he wo epesenaons ae obsevaonally equvalen and fuhe assumpons need o be made o esmae he wo models. One possbly s o model he vaance of he asse euns as a GARCH pocess. In hs case, he me vaaon of condonal asse euns sems fom he me vaaon of faco vaances, as fo example n Kng e al (1994) and Engle e al (1990). Anohe possbly s o consde ha me vaaon n condonal mean euns sems fom me-vayng pces/sk pema of common faco sk, as fo example n Bekae and Hodck (199). The dynamc faco model also uses hs second appoach. The movaon fo hs s wofold. Fs, we would lke o focus on whehe a few Euopean-wde shocks can geneae common cycles n cuency and sock euns acoss counes. Thee s evdence n 6 The same esul s obaned hough mlde condons on he dosyncac componens n Fon and Lpp (000) and Fon e al (1999). BIS Papes No 1 03

5 Euope ha a few vaables have he ably o foecas euns on dffeen makes and fo dffeen ypes of asses. Canova and De Ncolo (1995), based on a heoecal model developed n Canova (1993), pesen some empcal evdence on he elaon beween sock euns and eal acvy n Euope n he fom of Fama egessons. Calbaon of he heoecal model o Euopean daa suppos he vew ha nenaonal lnkages n sock euns emege because foegn vaables conan nfomaon abou he fuue pah of domesc vaables. In anohe pape, Canova and De Ncolo (1997) examne he elaon beween sock euns, he em sucue of nees aes, nflaon and eal acvy fo he Uned Saes, Japan, he Uned Kngdom and Gemany fom an open economy pespecve. They fnd ha nomnal sock euns ae lnked wh US nflaon and Uned Saes, ahe han Euopean eal vaables, and ha eal and fnancal vaables do no espond o nnovaons n nflaon and exchange aes. Paels (1997) confms fo he Uned Saes ha vaables ha pedc he US busness cycle, such as he em spead, have he ably o pedc US sock euns. The second movaon fo usng a dynamc faco model s ha, when usng weekly o daly daa, asse pcng models ha mpose me vaaon n second momens pefom well empcally, and he GARCH modellng appoach seems moe suable; wh monhly daa howeve, condonal eun vaances appea o be consan wheeas me vaaon n he condonal mean s moe mpoan, and heefoe, he second appoach should be moe appopae. Pedcably of sock euns, whch s assocaed wh me-vayng expeced euns, s manly obseved ove long hozons, as shown fo he US by Fama (1990), and Schwe (1990). Howeve, changes n he condonal vaance of sock euns ae obseved manly n daly and weekly daa and no ove longe peods. In pacula, volaly does no seem o move wh busness cycles, wheeas hee s some evdence (n he Uned Saes) ha expeced euns do (Schwe (1990), Havey (1991)). Foecass of excess sock euns do no appea o move popoonally wh esmaes of he condonal vaance (Havey (1989, 1991)). Fnally, fom a heoecal pon of vew, one would lke ulmaely o deve me-vayng volaly of euns endogenously fom a geneal equlbum model. Fo example, he asse pcng escon ha we wll deve n he nex secon can be obaned hough he consumpon capal asse pcng model f d he sochasc dscoun faco, s nepeed as he common neempoal magnal ae of subsuon n consumpon, wh powe uly funcon. Unfounaely, as Campbell (1998) pons ou, hee s no evdence of cyclcal vaaon n consumpon o dvdend volaly ha could be he souce of sock make volaly o he souce of me-vayng mean euns. 3. Asse pcng In he pevous secon, we mposed a faco sucue fo he asse euns. Now we wll deve a pcng escon ha mus hold fo all asses n evey make unde he assumpon of full negaon. Then we wll show how o esmae he model f we elax hs assumpon and how o consuc a measue of negaon fo each make n each couny. In he geneal case, any faco model mples he followng escon fo he condonal mean of euns usng ou pevous noaon, whee K k s he pce of sk fo he h k sk faco 7 j j E 1 > kk fo j c, (6) k 1 Ths escon can be obaned n dffeen ways and n each case hee wll be a dffeen nepeaon fo he K pced souces of sk. Fo example, n Campbell (1996) he escon obans n an neempoal asse pcng model, fo a closed economy consumpon CAPM, whle n Adle and Dumas (1983) and Dumas (1994), obans fo an open economy consumpon CAPM wh dosyncac exchange ae sk. Equvalenly, he pcng escon can be obaned by usng abage pcng heoy. If no abage oppounes exs, s possble o show ha, unde some condons on he sze of he dosyncac componen, a pcng kenel o sochasc dscoun faco wll always exs and ha wll allow asses o be pced coecly hough s covaance wh he eun on each asse. 7 The sk pema k belong o he nfomaon se I BIS Papes No 1

6 Ths appoach s paculaly useful n ou conex snce, unde he model assumpons, f we allowed he coss secon o ncease asympocally and hen fomed K pofolos usng he asses a hand, hese aggegae pofolos would conan no dosyncac sk. Snce he pedcable componen of he eun of each aggegae pofolo s a lnea combnaon of he K-faco sk pema, we can use condonal expeced aggegae euns as esmaes of he faco sk pema. Kng e al (1994) show fo a sac faco model wh me-vayng condonal faco vaances ha, unde a mld no abage condon and unde he assumpon ha he dosyncac componen vanshes as he coss-seconal dmenson nceases asympocally, hee exss a sochasc dscoun faco d whch pces he avalable asses by dscounng he andom payoffs o he pesen value. Snce he condon on he dosyncac componen s also sasfed by hs dynamc faco model, we wll follow he lne of agumen o oban a pcng elaon unde he null hypohess of compleely negaed Euopean makes. Unde he hypohess ha fnancal makes ae fully negaed, hee exss a sochasc dscoun faco whch pces all ypes of asses n all makes. The dscoun faco can be hough of as he eun on a pofolo ha capues only aggegae souces of sk. Fo example, n a closed economy APT model, he pcng kenel s educed o he eun on he sk-fee asse. In a consumpon CAPM model, he pcng kenel s he neempoal elascy of subsuon n consumpon. In ohe wods, he pcng kenel povdes us wh a measue wh whch o evaluae he skness of he asses. As wh obsevable benchmak asse pcng models, he pemum of he asse depends on s covaance wh he benchmak pofolo, n hs case d. Snce we ae consdeng cuency euns ha ae n excess of he sk-fee ae and sock euns ha ae hedged fo cuency sk, he absence of abage oppounes n pefecly negaed makes mples he followng pcng escon on euns : j E 1d 0 fo j c, (7) Fuhemoe, snce d s a eun on an asse, has a faco epesenaon as n (1): d d * whee d * K k1 C E * k 0 1 d u k A (*) (8) Now, eplacng he defnon fo d fom (8) and fo euns fom (-3) n (7) and unde he model assumpons (1) o (3), oban: E K j * j * * ( j) 1 d 0 d E 1 Ck0C jk(0) Ik E 1A A 0 fo j c, k 1 Unde he null of pefecly negaed makes, d s, by defnon, he eun on a well dvesfed pofolo, heefoe he dosyncac em s zeo n condonal mean squaes (assumpon (3) n he model). So asse excess euns and d ae coelaed only hough he common sk facos u 1,..., u K and as a consequence, he las em of he above sum conveges o zeo. I follows ha he pcng escon (7) becomes: E 1 wh F K * Ck0 * k 1 d * C 0 0 j j Cjk Ik E 1 C k k * d I k 0 fo j c, and k 1... K K k 1 jk F k whee F k ae he K-faco sk pema. 8 Equaon (9) s he lnea faco pcng model fo sk and povdes a connecon beween he condonal mean of euns and he faco sk pema. Faco sk pema measue he amoun of expeced eun ha he agen s wllng o gve up o educe vaably (9) 8 Noce ha F k l 1 snce d l 1. BIS Papes No 1 05

7 by I k uns. Noce ha he sk pema depend on he common facos (shocks), no he asses, and ha unde he null of compleely negaed makes, dosyncac sk s no pced. Faco sk pema ae me-vayng because he condonal mean of he pcng kenel, d *, s me-vayng. Full 1 negaon mples ha all sk pema wll be popoonal o. The nex secon explans how o * d poceed wh esmaon and esng. 4. Esmaon and esng The pcng equaons n (9) sae ha he N condonal expeced euns on he cuency and sock pofolos ae popoonal o he expeced euns on K well dvesfed pofolos o, equvalenly, o J lnea combnaons of he K-faco sk pema, C(0)F. In he nex secon, we follow he mehodology poposed n Fon and Rechln (1998) o consuc J aggegaes and esmae he common componen of euns. 4.1 Aggegaon and esmaon of he common componens Unde he assumpons (1)-(3) of he faco model, Fon and Rechln (1998) show ha when he coss secon s asympocally lage, he dosyncac componen vanshes hough aggegaon. Ths mples ha, f K s known, K aggegaes and he common shocks span he same space and, heefoe, we can use he aggegaes o deemne he numbe of common (pced) sks unde he null of compleely negaed makes. Aggegaon can be acheved usng dffeen ypes of aveagng sequences as long as hey sasfy he popees pesened n Fon e al (1999). One possbly s o use smple aveages, bu we mus check ha he aggegaes obaned n hs way ae no collnea. Collneay would have as a poenal consequence he undeesmaon of he dmenson of he faco space K. One advanage of akng smple aveages compaed o ohe aggegaon mehods, such as sac o dynamc pncpal componens, s ha hey poduce aggegaes whch ae saghfowad o nepe. We consuc he aggegaes by aveagng each vaable ove N counes. c 1 1 N N N N c dy dy fp fp,,, N k 1 N k 1 N k 1 N k To esmae K, we use a pocedue based on he dynamc egenvalues of descbed n Fon e al (1999). Then, o oban a conssen esmae of he common componen, we egess each vaable (demeaned) on he pas, pesen and fuue of he aggegaes as n equaon (10): p j j j C j, l l Aˆ Rj j c,, dy, fp l p (10) Fnally, we pefom dagnosc ess on he esmaed dosyncac componens, ae only mldly coelaed, as s equed by he model assumpons. j  o confm ha hey 4. Measung he degee of negaon In hs secon, we defne he degee of negaon beween wo makes n dffeen counes, dsenangle wo souces of Euopean-wde sk and sudy he evoluon. Senana e al (1999) and De Sans e al (000) fnd ha he pospec of Euopean moneay unon has manly had wo effecs: fs, o educe he pemum assocaed wh nees ae flucuaons, as a esul of a sngle moneay polcy. In he sudy, Senana e al (1999) fnd ha lowe dosyncac exchange ae sk leads o lowe nees ae sk pema, one of he easons beng ha, wh a sngle cuency, naonal cenal banks ae no foced o defend he cuency agans ohe Euopean cuences. Second, hey fnd evdence ha alhough he sngle cuency elmnaes na-euopean cuency sk, hs effec s small elave o he ncease n he pemum fo non-emu sk. 06 BIS Papes No 1

8 We defne he degee of negaon of make j n couny o be he adjused R of egesson (10). Then, o dsenangle he evoluon of he pema fo wo souces of common sk, aggegae cuency sk and aggegae make sk, we use he followng defnons: fs, we assume ha aggegae exchange ae sk s capued by he eun on he aggegae cuency pofolo. Aggegae cuency pofolos do no conan ohe ypes of aggegae o dosyncac sk. Second, we defne wha emans once exchange ae sk s accouned fo as he sk assocaed wh a couny's sock make. c a a c0 0 a c1 a e c 1 e c (11) c The componens e and e epesen he aggegae eun n excess of he sk-fee ae ha ewads cuency sk and make sk, especvely. Dd he elmnaon of na-euopean cuency sk also educe sk wh espec o he dolla To wha exen ae co-movemens n sock euns due o Euopean-wde common make shocks To answe hese quesons, we use he followng decomposon: wh J aggegaes, he model s assocaed wh a measue of f defned pevously as R j. We un a egesson of he common componen of cuency c euns (afe we have conolled fo he nfluence of ) on c e, and he assocaed R c,c s he pecenage of oal vaance explaned by he ewad o aggegae cuency sk. Ths eflecs he pa of he common flucuaons of cuency pofolo euns n R,c ha can be explaned by he aggegae cuency sk pemum. In he same way, R,c eflecs he mpoance of he componen of common flucuaons of sock euns ha ewads EU-wde cuency sk. Fnally, R, measues he mpoance of EU-wde make sk n explanng he common componen of sock euns n couny. To summase, R c,c, R, and R,c gve an ndcaon of he pa of oal vaance of he common componen of euns explaned by sk pema and ae, n fac, he paal coelaon coeffcens of c and c wh espec o c and c c c c c 0 1 c, c compued usng he followng egessons: C C C w R (1) C C C w R R (13) c 0 1,,, c In he absence of pefec capal make negaon, we ae neesed n fndng ou whehe fnancal negaon has nceased noneheless, and how he elave mpoance of he dffeen componens evolves ove me. The sample (1979:1-1997:1) was spl no fou subsamples, wh beak daes 1984:4, 1989:4 and 1993:6. Fuhemoe, we use ollng esmaon of he R j (equaon (10)) o denfy daes assocaed wh a seady ncease (o decease) of fnancal negaon. We use a 36- monh egesson wndow, sang fom he peod 1979:-198: and move hs wndow fowad by one monh a a me. Fnally, we would lke o nvesgae whehe he souces of he common flucuaons n sock euns ae assocaed wh he economes of some Euopean counes n pacula, he US economy o he US sock make. To answe hese quesons, we egess he common componen of sock euns on aggegae ndusal poducon gowh (, logip ), aggegae ndusal poducon gowh n he Uned Saes, logipus ) and sock euns n he Uned Saes, logrus ). ( ( ˆ a, log( IP ) b, log( IPUS ) c, log( RUS ) (14) The esmaed coeffcens and he paal coelaon coeffcens n hs egesson wll ell us f he souce of Euopean-wde sock make sk les n he Euopean busness cycle, he US busness cycle o spllove effecs fom he US fnancal makes. BIS Papes No 1 07

9 5. Empcal applcaon 5.1 Daa We esmae he models descbed n he pevous secons usng monhly daa fo cuency and sock euns on egh Euopean makes beween Januay 1979 and Decembe Cuency euns wee consuced usng exchange aes n excess of he fowad ae fo he pevous monh, whch unde nees ae pay s equvalen o exchange ae changes n excess of he dffeence beween he euocuency ae on he London make and he one-monh US Teasuy bll ae. Excess equy euns wee consuced fom pce and dvdend yeld daa and wee expessed n home cuency n excess of he euocuency ae on he London make. Noce ha he sum of equy euns and cuency euns yelds he dolla eun n excess of he US sk-fee ae fo an equy nvesmen n couny j make. The egh counes consdeed wee: Belgum, Fance, Gemany, Ialy, he Nehelands, Span, Fnland and he Uned Kngdom. Of hese, he Uned Kngdom does no pacpae n EMU. Sock pofolos fo each couny ae capalsaon-weghed make pofolos and a couny level hey epesen well dvesfed pofolos, n he sense ha all seco-specfc sk has been elmnaed and only couny-specfc sk s pesen. We also consde dvdend yelds (log(dv /P ), and fowad pema (log(f /e ). The faco model allows us o capue he dynamcs of he asse euns. In pacula, hese vaables have been shown by Bekae and Hodck (199) and Campbell and Hamao (199) o have foecasng powe fo he cuency and sock euns. Table 1, panel A povdes summay sascs on he excess euns n he sample ove he ene peod. Cuency euns ae chaacesed by lowe means han sock euns. Fance, Gemany, he Nehelands and he Uned Kngdom pesen negave excess cuency euns, mplyng ha hese pofolos consue a hedge fo he peod unde sudy. The coss-seconal vaaon of sandad devaons s elavely low, n ageemen wh ohe sudes, angng fom 11.48% (Fnland) o 13.% (Span). Aveage equy excess euns ange fom 7% (Uned Kngdom) o 14% (Span) n annualsed ems. The especve sandad devaons ae 13.01% and 1.17%. In ems of capalsaon, he lages makes n Euope ae he Uned Kngdom, whch epesens one hd of oal capalsaon, and he Fench and Geman makes, whch ogehe accoun fo anohe hd of oal EU-11 capalsaon. The Fench make pesens a mean of 7.48% and sandad devaon of 1.04%, whch makes he hd mos volale Euopean make n ou sample afe Ialy and Span. The Geman make pesens a mean excess eun of 7.94%, and volaly of 16.91%. Table 1, panel B pesens summay sascs on dvdend yelds and fowad pema. Noce ha all vaables ae saonay excep fo dvdend yelds, and ha hee ae clealy some mpoan dynamcs n euns and n fowad pema. Table pesens he conempoaneous coelaon coeffcen beween cuency and sock excess euns. Fo cuency euns, a compason of coelaon aveages compued by excludng coelaon wh he couny self leads us o fom hee goups of counes: he fs ncludes Ialy, Fnland and Span wh aveage coelaon 7%, he second conans he Nehelands, Belgum, Fance and Gemany wh aveage coelaon 83% and fnally, as expeced, he Uned Kngdom sands alone wh 67%. Aveage sock eun coelaons ae vey much lowe, he maxmum pesened by he Nehelands and Belgum (43% and 45% especvely) and he mnmum by Fnland (7%). The aveage coelaon fo he ohe makes does no vay (3% o 37%). Coelaons fo boh ypes of pofolo euns appea o be que song, suggesng ha makes ae negaed a leas o some degee, and, n pacula, because of he ERM, cuency makes co-move moe songly han equy makes. Table, panel B pesens he coss-couny coelaon coeffcens beween cuency and sock pofolos, and means ove all counes. Fs noce ha coelaons ae negave. Fuhemoe, appeas ha foegn exchange and sock makes co-move elavely songly n he Uned Kngdom ( 19.4%), Belgum ( 0.4%) and he Nehelands ( 8.9%). Splloves fo all he ohe makes ae beween 16% and 1%, excep fo Fance, whee he wo makes appea o move ndependenly fom each ohe. Lookng a he aveage coss-coelaons, we see ha sock euns ae moe affeced by cuency flucuaons han he conay. The Fench cuency make s he leas sensve o foegn sock make flucuaons. 08 BIS Papes No 1

10 Table 1 Panel A: mean ( ), sandad devaon ( I ) and auocoelaon coeffcen ( H ) fo c cuency euns n USD ( ) and sock euns n naonal cuency ( ), n pecenages, annualsed Peod: 1979:0-1997:1 c I 1 H Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Panel B: mean ( ), sandad devaon ( I ) and auocoelaon coeffcen ( H 1 ) fo dy fp cuency euns n USD ( ) and sock euns n naonal cuency ( ), n pecenages, annualsed Peod: 1979:0-1997:1 dy I H (1) Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom I fp I 1 H 1 H 1 BIS Papes No 1 09

11 Table Panel A: coelaon coeffcens beween cuency and sock pofolos. Above he dagonal c c co, ' co, ' fo, ' = 1...N ae and below he dagonal ae BE FR DE IT NL ES FI GB mean Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom mean c x c Panel B: coss-coelaon coeffcens beween cuency and sock pofolos co, ' c On he dagonal ae co, fo, ' = 1...N. BE FR DE IT NL ES FI GB mean Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom mean Inegaon To esmae he degee of negaon, he fs sep s o consuc he aggegae vaables, cuency and sock pofolos, aggegae dvdend yelds and fowad pema, usng he mehodology descbed n he pevous secon, and hen esmae he common componens. We also have o check ha he aggegaes consuced n hs way ae no pefecly collnea; f hey wee, we would be a sk of undeesmang he numbe of facos. The esuls n Table 3 show ha he aggegaes ae no pefecly coelaed: maxmum coelaon s beween aggegae cuency euns and aggegae fowad pema ( 53.6%), mnmum coelaon s beween aggegae dvdend yelds and sock euns. We esmae K and fnd ha s equal o fou (K = 4). Nex, we esmae he common componen fo he cuency and sock pofolos and compue he coespondng adjused coeffcens of deemnaon, R j. Followng Fon and Rechln (1998), o esmae he dsaggegaed model we egess he ndvdual cuency and sock euns on he pesen, pas and fuue of he aggegaes. The R j of hese OLS egessons can be used o assess he elave mpoance of he common and dosyncac componen fo each vaable. These values ae shown n Table 4, fo all fou vaables 10 BIS Papes No 1

12 and fo fou subpeods. The coespondng R j s a measue of he f of he dynamc faco model, and s also a measue of he degee of negaon, n he sense ha epesens he conbuon of he common componen o he oal vaance fo each vaable n each couny. We heefoe concenae on he R j fom he cuency and sock euns. The fs column pesens he R j ove he whole peod, wheeas he subsequen columns pesen he esuls fo he fou sepaae subsamples. ( j) ( j') Coelaon beween aggegaes co, Table 3 fo j, j' = c,,dy,fp, fo aggegae cuency, sock pofolos, aggegae dvdend yelds and fowad pema Panel A: cuency euns c dy fp c dy fp Table 4 Pecenage of oal vaaon of excess cuency, sock euns, dvdend yelds and fowad pema explaned by he common componen R adj fom JN egessons fo he esmaon of he common componens (I. 1979:0-1984:04, II. 1984: :04, III. 1989: :06, IV. 1993: :1) Panel A: cuency euns I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Panel B: sock euns I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom (j) BIS Papes No 1 11

13 Panel C: fowad pema I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Panel D: fowad pema I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Foegn exchange makes appea o co-move moe songly han equy makes, he hgh degee pesened by he foegn exchanges n Belgum, Gemany, he Nehelands and Fance. The UK make appeas o move moe ndependenly. Noce ha s he only make fo whch he R j nceases ove he second peod, pobably because selng joned he EMS n Decembe 1989 even f evenually dopped ou. Ialy, Span and Fnland le somewhee n beween. Sock makes ae clealy less negaed han foegn exchange makes, he lowes degee of co-movemen aaned by Fnland (39.6%). Unde he null of pefecly negaed makes, he same aggegaes should have been able o explan equally well he co-movemens n boh sock makes and equy makes, bu hs s no he case. Table 4 shows ha he aggegaes explan co-movemens n he foegn exchange makes bee. Howeve, s also clea fom Table 4 ha hee has been a posve evoluon n equy makes owads negaon. Compang he R j ove he fou subsamples, we see ha he ncease has been moe pomnen n small makes such as Belgum, Span and Fnland, whee he same common shocks double he explanaoy powe beween he fs and he las peod. The ncease s smalle fo Gemany and Fance. The UK s degee of make negaon emans unchanged. We obseve a dffeen evoluon n he foegn exchange makes, whee he R j eman elavely consan ove he fs hee peods, and hen decease n he fouh, mplyng ha he vaaon n exchange aes wh espec o he US dolla becomes dosyncac. Nex, we examne he evdence povded by he ollng esmaon usng a wndow of hee yeas and movng fowad by a monh. Gaphs 1-4 pesen gaphs of he ollng R j fo he cuency and sock pofolos. They confm ha he R ae ndeed consan fo Belgum, Fance, Gemany and he Nehelands, whch have been n he EMS longe. Counes whose cuences wee a he cene of he cuency css, e Fnland, Ialy, Span and he Uned Kngdom, show moe vaaon ove he sample: noce he lage decease n 1985 and 199 fo Fnland and he seady decease afe md-1993 fo Ialy and he Uned Kngdom. As fa as he sock makes ae concened, appeas ha, as n he pevous analyss, small makes become moe negaed. Howeve, hee ae dffeences n mng. Fo Belgum and Fnland, he pocess aleady sas n 1979 and sablses afe In Span, he pocess sas lae (1989) and has peaked by The ollng esmaons eveal ha Gemany 1 BIS Papes No 1

14 and he Nehelands also follow a smla pocess, sang n 1988 and peakng n 1990 fo he Nehelands and 1993 fo Gemany. In concluson, hee appea o be dffeences beween counes wh egad o he sang daes of he negaon pocess and he me akes fo he pocess o peak. Gaph 1 Cuency euns: esmaon of R j ove he ene peod, fou subsamples and ollng esmaon fo Belgum (BE), Fance (FR), Gemany (DE) and Ialy (IT) BE FR Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 DE IT Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 BIS Papes No 1 13

15 Gaph Cuency euns: esmaon of R j ove he ene peod, fou subsamples and ollng esmaon fo he Nehelands (NL), Span (ES), Fnland (FI) and he Uned Kngdom (GB) NL ES Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 FI GB Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan BIS Papes No 1

16 Gaph 3 Sock euns: esmaon of R j ove he ene peod, fou subsamples and ollng esmaon fo Belgum (BE), Fance (FR), Gemany (DE) and Ialy (IT) BE FR Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 DE IT Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 BIS Papes No 1 15

17 Gaph 4 Sock euns: esmaon of R j ove he ene peod, fou subsamples and ollng esmaon fo he Nehelands (NL), Span (ES), Fnland (FI) and he Uned Kngdom (GB) NL ES Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 FI GB Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Jan 80 Jan 85 Jan 90 Jan 95 Jan 00 Fo ou nex pon, we nvesgae whehe he posve evoluon n equy makes s due o an ncease n he EU make sk pemum. Fs, Panel A of Table 5 llusaes he evoluon of foegn exchange makes. The aggegae exchange ae sk pemum explans mos of he vaance of he common componen of cuency euns (>95%), wh he excepon of Span (86%). Ths confms ou assumpon ha he aggegae cuency pofolo eflecs he cuency sk pemum, e he pemum equed by nvesos fo holdng a pofolo of Euopean cuences. Panel B of Table 5 shows he decomposon of he degee of sock make negaon no wo componens: one lnked o a cuency sk pemum and he ohe lnked o a make sk pemum. Aggegae make sk explans moe han 88% of he vaance of he common componen of sock euns, excep n he case of Fnland (74%). As befoe, hs componen says nvaan dung he fs hee subpeods and hen nceases shaply n he fouh, n all counes excep fo he Nehelands (fom 79% o 64%) and Fance (fom 64% o 51%). Wha s he mpoance of sysemac cuency sk n he pcng of Euopean socks To answe hs queson, we examne he R,c n panel C of Table 5. Ove he whole peod, aggegae cuency sk does no seem o play a ole fo sock valuaon, excep n he case of he Fench make. Howeve, he evoluon acoss subpeods s que dffeen acoss makes. The cuency pemum nceases n he Nehelands, Belgum and he Uned Kngdom, and deceases n Fance and Span. The gowng degee of negaon ha we have obseved n Table 4 appeas o be due o an nceasng EU-wde make pemum and a deceasng cuency pemum, excep fo he Nehelands and he Uned 16 BIS Papes No 1

18 Kngdom (whch also show an nceasng cuency pemum). Ths esul suppos he dea of EU-wde make sk eflecng EU busness cycle sk: As economes become moe negaed, he synchonsaon of busness cycles nceases sysemac sk and s pemum. On he ohe hand, elmnaon of na-euopean cuency sk educes he cuency pemum, a leas fo he counes pacpang n he euo. Only n he Nehelands and he Uned Kngdom does he componen of cuency sk n he nvesmen pofolo ncease. Ths esul agees wh De Sans e al (000), who fnd ha he Euopean componen of cuency sk n an nenaonal nvesmen pofolo nceases n he 1990s (even f he elave ncease n he exa-euopean componen s moe mpoan). Table 5 Relave mpoance of he make and cuency sk pemum n cuency euns (Panel A) and sock euns (Panels B and C). We epo he paal R fo egessons (1) and (13). I. 1979:0-1984:04, II. 1984: :04, III. 1989: :06, IV. 1993: :1 Panel A: R c,c I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Panel B: R, I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Panel C: R,c I-IV I II III IV Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom BIS Papes No 1 17

19 Havng esmaed he common componen of cuency and sock euns, we use hem o examne he souces of sock eun co-movemen. Do make and cuency pema eflec ewads o a common busness cycle sk o do hey eflec sysemac esponses of EU makes o US equy makes Table 6 pesens he esuls fom egesson (14). I appeas ha ndusal poducon, Euopean o US, does no help explan he common componen of sock euns n Euopean makes. On he ohe hand, hee ae some splloves fom he US sock makes: 17.8% of co-movemens n Belgum, 16.% n he Uned Kngdom and 14% n Fance and Gemany can be explaned by US make-elaed facos. We conclude ha even f hee ae splloves fom US makes o Euopean equy makes, he sysemac effec s no vey lage. Table 6 Souces of sock make co-movemen fom egesson (14). R p, R p,us, R,us ae he paal coelaon coeffcens fo aggegae IP gowh n Euope, aggegae IP gowh n he Uned Saes and sock euns n he Uned Saes. R p R,us R p,us Belgum Fance Gemany Ialy Nehelands Span Fnland Uned Kngdom Summay and concluson Ths pape examnes whehe he convegence of Euopean economes owads economc and moneay unon has lead o negaon of Euopean sock makes. Thee ae seveal easons why economc negaon should mply fnancal negaon. Apa fom he convegence of nflaon and sho-em nees aes, convegence of moneay and fscal polces leads o convegence of eal expeced cash flows and o nceased synchonsaon of busness cycles acoss Euopean economes, whch n un leads o hghe coelaons of sock euns. Fuhemoe, snce 1993, na- Euopean exchange aes have been fxed hough he EMS, so na-euopean exchange ae sk assocaed wh exchange ae flucuaons should have been gadually elmnaed. Assessng whehe capal makes ae negaed s mpoan n ode o measue he effecve escons on capal flows n Euope and he effecveness of he polces amed a he lbealsaon of capal makes. I s also mpoan fo nvesos: f makes have ndeed become fully negaed, opmal pofolo composon should shf fom couny dvesfcaon o seco dvesfcaon. And fo fms: f negaon educes he cos of ssung new sock, may encouage nvesmen. The pape examnes whehe he sock makes of egh Euopean counes ae fully negaed usng a double appoach. Fs, we defne a geneang pocess fo euns ha allows us o explo he common dynamcs of cuency euns, sock euns, fowad pema and dvdend yelds. The model assumes ha each vaable follows a dynamc faco analycal model, and decomposes he vaables no a common and an dosyncac (vaable- and couny-specfc) componen. Fnancal negaon s hen defned as a pocess wheeby sock makes become nceasngly affeced by he common, EU-wde sk facos, whle he nfluence of couny-specfc sks s gadually educed. In compleely negaed makes, couny-specfc sks ae fully dvesfable and hus nvesos eque no ewad o hold asses ha conan such sk. In ohe wods, n a compleely negaed make nvesos face boh common and dosyncac souces of sk, bu hey pce only he fs. Imposng a mld no abage condon on he geneang pocess fo euns yelds exacly hs pcng escon fo 18 BIS Papes No 1

20 euns. Explong he popees of he faco model o consuc well dvesfed pofolos, he pape examnes whehe he daa sasfy he pcng escon. Then measues he degee of negaon and examnes s evoluon dung wo peods. Fnally, he pape nvesgaes whehe he souces of common sk le whn Euope o have splled ove fom eal and fnancal vaables n he Uned Saes, and seeks o deemne he fnancal componen of a couny's nflaon. The empcal applcaon has shown ha Euopean equy makes ae no pefecly negaed and has found ha he makes examned n hs sudy show smla degees of negaon fo he end of he peod unde sudy. Howeve, he songes evoluon occued fo he smalles makes, e Belgum, Span and Fnland. The mpoance of he common componen vaes acoss counes and vaables bu s geneally hghe fo foegn exchange makes. Fuhemoe, we have found ha he degee of negaon s consan fo cuency makes unl 1994, wheeas nceases songly fo equy makes dung he 1980s and 1990s. Thee appea o be dffeences n mng beween counes as fa as he sa of he pocess s concened. Ths ncease s pmaly due o an ncease n he pemum assocaed wh Euopean-wde make sk and a decease n he pemum assocaed wh flucuaons of Euopean cuences wh espec o he US dolla. Fnally, we have found ha he souces of he common shocks canno be explaned by changes n Euopean o US ndusal poducon and ha hey le only n pa n he US equy makes. Refeences Adle, M and B Dumas, (1983): Inenaonal pofolo selecon and copoaon fnance: a synhess, Jounal of Fnance no 38, pp Baley, W and J Jagan (1994): Foegn owneshp escons and sock pces n he Tha capal make, Jounal of Fnancal Economcs no 36, pp Bekae, G and C R Havey (1995): Tme-vayng wold make negaon, Jounal of Fnance, vol 50(), pp Bekae, G, C R Havey and R L Lumsdane (1998): Dang he negaon of wold equy makes, NBER Wokng Pape no 674, Sepembe. (1999): Sucual beaks n emegng make capal flows, NBER Wokng Pape no 719. Bekae, G and R H Hodck (199): Chaacezng pedcable componens n excess euns on equy and foegn exchange makes, Jounal of Fnance, vol 47(), pp Bonse-Neal, C, G Baue, R Neal and S Whealy (1990): Inenaonal nvesmen escons and closed-end couny fund pces, Jounal of Fnance, vol 45, pp Campbell, J Y (1996): Undesandng sk and eun, Jounal of Polcal Economy, no 104, pp (1998): Asse pces, consumpon and he busness cycle, NBER Wokng Pape no Campbell, J Y, and Y Hamao (199): Pedcable sock euns n he Uned Saes and Japan: a sudy of long em capal make negaon, Jounal of Fnance, vol 47(1), Mach, pp Canova, F and G De Ncolo (1995): Sock euns and eal acvy: a sucual appoach, Euopean Economc Revew, no 39, pp (1997): Sock euns, em sucue and eal acvy: an nenaonal pespecve, mmeo. Canova, F and J Manan (1995): Pedcng excess euns n fnancal makes, Euopean Economc Revew, no 39, pp Chelley-Seeley, P and J M Seeley (1999): Changes n he comovemens of Euopean equy makes, Economc Inquy, no 37(3), pp Cheng, A C S (1998): Inenaonal coelaon sucue of fnancal make movemens - he evdence fom he UK and he US, Appled Fnancal Economcs, no 8, pp 1-1. De Sans and Gead (1998): How bg s he pemum fo cuency sk Jounal of Fnancal Economcs, no 49, pp BIS Papes No 1 19

21 (1997): Inenaonal asse pcng and pofolo dvesfcaon wh me-vayng sk, Jounal of Fnance, vol 5(5), pp De Sans, Gead and Hllon (1998): The elevance of cuency sk n he EMU, mmeo. Danhne, J-P, F Gavazz and E-L von Thadden (000): Euopean fnancal makes afe EMU: a fs assessmen, CEPR Dscusson Pape no 413, Mach. Deken, C and P Haman (000): The euo and nenaonal capal makes, Euopean Cenal Bank, Wokng Pape no 19, Apl. Dumas, B (1994): A es of he nenaonal CAPM usng busness cycles ndcaos as nsumenal vaables, NBER Wokng Pape no 465, Febuay. Dumas, B and Solnk (1995): The wold pce of foegn exchange sk, Jounal of Fnance, vol 50(), pp Engle, R F, V K Ng and M Rohchld (1990): Asse pcng wh faco-arch covaance sucue - empcal esmaes fo easuy blls, Jounal of Economecs, no 45, pp Fama, E F (1990): Sock euns, expeced euns and eal acvy, Jounal of Fnance, vol 45 (4), pp Fama, E F and K R Fench (199): The coss-secon of expeced sock euns, Jounal of Fnance no 47(), pp Feson, W E and C R Havey (1999): Economc, fnancal and fundamenal global sk n and ou of he EMU, NBER Wokng Pape no (1994): Souces of sk and expeced euns n global equy makes, Jounal of Bankng and Fnance, no 18, pp (1993): The sk and pedcably of nenaonal equy euns, Revew of Fnancal Sudes, vol 6, no 3, pp Fon, M and L Rechln (1998): Le s ge eal: a faco analyc appoach o dsaggegaed busness cycle dynamcs, Revew of Economc Sudes, no 65, pp Fon, M, M Halln, M Lpp and L Rechln (1999): The genealzed dynamc faco model: denfcaon and esmaon, Revew of Economcs and Sascs, fohcomng. Fon, M and M Lpp (000): The genealsed dynamc faco model: epesenaon heoy, Economc Theoy 17, pp Hadouvels, G, D Mallaopoulos and R Pesley (1999): EMU and Euopean sock make negaon, CEPR Dscusson Pape no 14. Havey, C R (1989): Tme-vayng condonal covaances n ess of asse pcng models, Jounal of Fnancal Economcs no 4, pp (1991): The wold pce of covaance sk, Jounal of Fnance, vol 46(1), pp Havey C R, B Solnk and G Zhou (1994): Wha deemnes expeced nenaonal asse euns, NBER Wokng Pape, no 4660, Febuay. Heala, P T, (1989): Asse pcng n paally segmened makes: evdence fom he Fnnsh make, Jounal of Fnance, vol 44, pp Hodck, R J, D T Ng and P Sengmuelle (1999): An nenaonal dynamc asse pcng model, NBER Wokng Pape no Kng, M, E Senana and S Wadhwan (1994): Volaly and lnks beween naonal sock makes, Economeca, no 6(4), pp Lemmen, J J G and C W Ejffnge (1995): The fundamenal deemnans of fnancal negaon n he Euopean Unon, mmeo. Paels, A D (1997): Sock eun pedcably: he ole of moneay polcy, Jounal of Fnance, vol 5(5). Poes, R and H Rey (1999): The deemnans of coss-bode equy flows, CEPR Dscusson Pape no 5. 0 BIS Papes No 1