Global Financial Cycles and Risk Premiums

This paper studies the synchronization of financial cycles across 17 advanced economies over the past 150 years. The comovement in credit, house prices, and equity prices has reached historical highs in the past three decades. While comovement of credit and house prices increased in line with growing real sector integration, comovement of equity prices has increased above and beyond growing real sector integration. The sharp increase in the comovement of global equity markets is particularly notable. We demonstrate that fluctuations in risk premiums, and not risk-free rates and dividends, account for a large part of the observed equity price synchronization after 1990. We also show that US monetary policy has come to play an important role as a source of fluctuations in risk appetite across global equity markets. These fluctuations are transmitted across both fixed and floating exchange rate regimes, but the effects are more muted in floating rate regimes.