International Financial Integration*

-29-

We turn to the returns on foreign liabilities in Table 5B. Column (1) shows that the return
on foreign portfolio equity liabilities co-moves strongly with the domestic stock market
index return and this specification has high explanatory power. This close relationship is a
demonstration of international risk sharing in action: selling shares to foreign investors
hedges the risk of fluctuations in domestic equity returns. Once again, the domestic stock
return explains returns on FDI at market value (column 3) much better than returns on
book-value FDI (column 2). In regard to debt liabilities, domestic bond returns explain
over ⅓ of returns on debt liabilities (column 4), and the yield on foreign debt liabilities is
well tracked by domestic interest rates (column 5).

The analysis of returns on foreign assets is further extended in Table 6 by comparing
returns on foreign assets to domestic market returns. We consider the aggregate return on
foreign assets in columns (1)-(2). The first specification shows that the return on foreign
assets positively and significantly co-varies with the domestic stock market, but the
elasticity is quite low and the explanatory power limited. Hence, holding foreign assets
provides some diversification against fluctuations in the local stock market. Column (2)
shows that the domestic bond return is also positively correlated with the aggregate return
on foreign assets, but with an elasticity well below ½, which is again consistent with a
diversification contribution from foreign assets.

We turn to the subcomponents of the overall foreign asset position in columns (3)-(5).
Column (3) shows that domestic stock returns are significantly positively correlated with
returns on foreign portfolio equity assets (there is a substantial global component to stock
market performance) but the point estimate of only 0.4 again signals the benefits from
diversification. The correlations between returns on foreign portfolio equity assets and
domestic debt (column 4), foreign debt assets and domestic debt (column 5), and yields on
foreign debt holdings and domestic debt (column 6) are of the same order of magnitude.

<<   29   30   31   32   33   34   35   >>

More intriguing information