How Much Do International Stocks Move Together: Correlation, Dispersion and Predictability by David G. McMillan :: SSRN

This paper considers both correlations and dispersion across a range of (48) international stock market returns. The paper also considers the links with key macroeconomic variables and thus, is informative as to the nature of risk and the interaction between the financial and real economies. While correlations have risen over the sample, as commonly observed, evidence suggests a greater dichotomy in the post-Covid-19 period. In seeking to understand correlation movement, inflation plays a greater role compared to growth, except for the markets of East Europe. Moreover, a negative relation implies that higher inflation leads to investors switching between markets. Differences are again noted for East Europe as well as the GCC region. Evidence of predictability arising from cross-sectional returns dispersion is missing in linear regressions, but is revealed through a Markov-switching approach, with coefficients of opposite signs across market phases. Again, linking to macroeconomic variables suggests that higher dispersion acts as a proxy for risk and indicates weaker future economic conditions. Overall, the results in the paper link market and economic risk factors. Where higher correlations imply a lessening of diversification opportunities (market risk), higher inflation typically results in investors looking to adjust portfolios (falling correlations), although this is not universal across markets. Dispersion acts as an economic risk factor implying changes in subsequent economic performance.