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What makes a country’s stock market more correlated with the U.S. stock market than others? This paper documents and investigates theoretically a strong positive cross-sectional relationship between the share of an equity market held by foreign investors, U.S. investors in particular, and the return correlations of 40 equity markets with the U.S. market. We argue that frictions impeding the cross-border holding of equity are key determinants of cross-border positions and equity market return correlations across countries. We develop an asset pricing model that illustrates how heterogeneity in cross-border asset holding costs can generate the observed cross-sections of cross-border positions, return correlations, and alphas with respect to a global market factor. We provide empirical evidence consistent with the model’s predictions. Overall, our results suggest that the portfolio demand channel emphasized in theoretical models of asset return comovement is indeed the primary driver of the cross-section of international equity return comovement, but only after taking into account the cross-sectional variation in frictions impeding equity investments across borders.


Comovement, cross-section of correlations, discount rate effect, international asset pricing


Author’s submitted manuscript.

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Economics Commons



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