Investigating the Drivers of International Comovement in Real Financial Asset Returns

There is a substantial body of theoretical and empirical research on asset price
comovement and determinants. The empirical analysis in this paper differs in that it
incorporates a channel for cross-country comovement in asset prices as well in a set of
proposed asset price determinants, across a sample of 9 OECD countries. A Bayesian
dynamic factor model is utilised to isolate common, or 'world', and country-specific
shocks in stock, bond, currency, and house markets and in variables representing
monetary policy, fiscal policy, productivity, demand, relative commodity prices and
macroeconomic sentiment. The results are used to gauge the degree of financial and
economic integration. Individual asset returns are then regressed on factors extracted
from the driving variables to examine the relative importance of the common and country
shocks. Stock and bond markets in particular are found to be driven largely by shocks
which are common across all countries and asset markets, though a country level cycle
in returns is also evident. Together the world factors in the driving variables are found to
be a relatively large source of shocks for all asset markets, with shocks to fiscal policy
variables, productivity and sentiment appearing to underpin international linkages in
asset return volatility. The country-specific component in relative commodity price growth
is a large driving force for individual returns.