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Country and sector effects in international stock returns revisited

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  • Sercu, Piet
  • De Moor, Lieven

Abstract

The starting point of this paper is the Heston and Rouwenhorst (1994) methodology, which decomposes stock returns into four factors: market factor, country factor, sector factor and idiosyncratic factor; all with unit exposures. First, we explain why discarding small firms may overstate the relative importance of sector effects in international stock returns: small caps turn out to have an above average variability (after controlling for sector and country effects) and to be less exposed to their global sector index than large caps. Secondly, we show that the unit exposure assumption in Heston and Rouwenhorst (1994) is empirically not valid, and we accordingly generalize the HR-methodology by taking into account the unequal distribution of exposures along countries and sectors. Thirdly, we decompose the stacked variance of exposures and factors into his moments and correct it for estimation error in the xposures. We show that ignoring exposures and estimation error in the exposures may also overstate the impact of sector effects on international stock returns. Lastly, we show that there is no necessary link between the outcome of the HR-methodology and benefits of international risk diversification.

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File URL: https://lirias.kuleuven.be/bitstream/123456789/230059/1/AFI_0615.pdf
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Bibliographic Info

Paper provided by Katholieke Universiteit Leuven in its series Open Access publications from Katholieke Universiteit Leuven with number urn:hdl:123456789/230059.

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Date of creation: 2006
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Handle: RePEc:ner:leuven:urn:hdl:123456789/230059

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Web page: http://www.kuleuven.be

Related research

Keywords: Determinants; Characteristics; Stock returns; Belgian firms; Variability; Distribution;

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References

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  1. Dušan Isakov & Frédéric Sonney, 2003. "Are practitioners right? On the relative importance of industrial factors in international stock returns," FAME Research Paper Series rp72, International Center for Financial Asset Management and Engineering.
  2. Campa, José Manuel & Fernandes, Nuno, 2004. "Sources of Gains from International Portfolio Diversification," CEPR Discussion Papers 4390, C.E.P.R. Discussion Papers.
  3. Sentana, Enrique, 2000. "Did the EMS Reduce the Cost of Capital?," CEPR Discussion Papers 2640, C.E.P.R. Discussion Papers.
  4. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  5. Gikas A. Hardouvelis & Dimitrios Malliaropulos & Richard Priestley, 2006. "EMU and European Stock Market Integration," The Journal of Business, University of Chicago Press, vol. 79(1), pages 365-392, January.
  6. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
  7. Heston, Steven L. & Rouwenhorst, K. Geert, 1994. "Does industrial structure explain the benefits of international diversification?," Journal of Financial Economics, Elsevier, vol. 36(1), pages 3-27, August.
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Cited by:
  1. Roberto A. De Santis & Lucio Sarno, 2008. "Assessing the benefits of international portfolio diversification in bonds and stocks," Working Paper Series 883, European Central Bank.
  2. Pieterse-Bloem, M., 2011. "The Effect of Emu on Bond Market Integration and Investor Portfolio Allocations," Open Access publications from Tilburg University urn:nbn:nl:ui:12-4742837, Tilburg University.

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