Financial Integration and Market (In)Efficiency in International Capital Markets
Final Report Abstract
In this project, I examined financial integration and market (in-)efficiency in international capital markets. The total project consists of several subtopics. I summarize the main results of the different subtopics in the following paragraphs. Examining a large set of 132 cross-sectional anomalies in international equity markets, I find many of the significant U.S. anomalies replicate in equally weighted portfolios. However, only few survive when mitigating the impact of tiny stocks, accounting for multiple testing, and using factor models to adjust for expected returns. Accounting for the former two, only 15 anomalies yield significant long–short returns in the ex-U.S. world cross-section. Most of these are value anomalies. Factor models hardly seem necessary for Japan and the Middle East. In other international markets, the best U.S. factor models help shrink the cross-sections further. Thus, investors should be careful in choosing their strategies and academics should focus on explaining the small set of really robust anomalies. Analyzing several Developed and Emerging international markets, I test the ability of global, regional, and local models to explain these anomalies. My main finding is that both global and regional factor models create substantially larger average absolute alphas than local factor models. Even for the most recent period, there is no evidence of a catchup of global and regional factor models. There is substantial potential for international diversification of anomaly strategies. Thus, investors have to be careful to choose the appropriate factor model to evaluate their investments and investment managers. In addition, we introduce a novel composite probability distortion (CPD) score. This measure is strongly and consistently priced in the cross-section of international stock returns: low-CPD-score stocks are underpriced while those with high scores appear overpriced. Individualism is the main driver of differences in the CPD premium across countries and U.S. states. Consistent with the substantially lesser degree of probabilistic thinking in collectivist cultures documented by the psychology literature, we find that the CPD premium is substantially higher in these than in individualist cultures. Investors can profitably exploit the documented premium. In addition, documenting the relation to collectivism may in particular help people living in these countries scrutinizing their investment decisions.
Publications
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Local, Regional, or Global Asset Pricing?. Journal of Financial and Quantitative Analysis, 57(1), 291-320.
Hollstein, Fabian
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Probability distortions, collectivism, and international stock prices. Leibniz University Working Paper
Hollstein, F. & Sejdiu, V.
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The world of anomalies: Smaller than we think? Leibniz University Working Paper
Hollstein, F.
