Selecting Macroeconomic Variables as Explanatory Factors of Emerging Stock Market Returns

Emerging stock markets have been identified as being at least partially segmented from global capital markets. As a consequence, it has been argued that local risk factors rather than world risk factors are the primary source of equity return variation in these markets. This paper seeks to address the question of whether macroeconomic variables may proxy for local risk sources. We find moderate evidence to support this hypothesis. Further, we investigate the degree of commonality in exposures across emerging stock market returns using a principal components approach. We find little evidence of commonality when emerging markets are considered collectively, however at the regional level considerable commonality is found to exist. Acknowledgments: We thank Trevor Breusch, Robert Faff, Barry Oliver, and delegates at the Australasian Finance & Banking Conference 1999 for their constructive comments on earlier drafts of the paper.

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