We provide a firm level analysis of the impact of capital market liberalization in 18 emerging markets. Consistent with models of international asset pricing, we find that firms’ stock returns increase during liberalization and that a majority of firms have lower mean returns and lower dividend yields after liberalization. We also find that emerging market firms have increased exposure to the world market and decreased exposure to the home market following liberalization. These changes in returns and exposures support the predictions of theoretical international asset pricing models. We also test and find support for the importance of size, local risk, foreign exchange risk, and cross-listing status in explaining the cross-section of changes in returns.

We investigate whether cross-listing shares in the form of depositary receipts in overseas markets benefits investors in emerging market countries during periods of local financial crisis from 1994 to 2002. We regress cumulative abnormal returns for three windows surrounding the crisis events on the cross-listing status while controlling for cross-sectional differences in firm age, trading volume, foreign exposure, disclosure quality and corporate governance. Further, we examine cross-listing effects in countries popularly thought to experience contagious effects of these crises. We find that cross-listed firms react significantly less negatively than non-cross-listed firms, particularly in the aftermath of the crisis. The results on contagious cross-listing effects are however mixed. Our findings are consistent with predictions based on theories of market segmentation as well as differential disclosure/governance between developed and emerging markets. We do not find evidence that foreign investors “panic” during a currency crisis.

We examine the relevance and effectiveness of stock return correlations among financial institutions as an indicator of systemic risk. By analyzing the trends and fluctuations of daily stock return correlations and default correlations among the 22 largest bank holding companies and investment banks from 1988 to 2008, we find that daily stock return correlation is a simple, robust, forward-looking, and timely systemic risk indicator. There is an increasing trend in stock return correlation among banks, whereas there is no obvious correlation trend among non-banks. We also disaggregate the stock returns into systematic and idiosyncratic components and find that the correlation increases are largely driven by the increases in correlations between banks’ idiosyncratic risks, which give rise to increasing systemic risk. Correlation spikes tend to predict or coincide with significant economic or market events, especially during the 2007–2008 financial crisis. Furthermore, we show that stock return correlations offer a perspective on the level of systemic risk in the financial sector that is not already captured by default correlations. Stock return correlations are not subject to data limitations or model specification errors that other potential systemic risk measures may face. Therefore, we recommend that regulators and businesses monitor daily stock return correlations among those large and highly leveraged financial institutions to track the level of systemic risk.

Using a GARCH approach, we estimate a time-varying two-factor international asset pricing model for weekly equity index returns of 16 OECD countries. A trade-weighted basket of exchange rates and the MSCI world market index are used as risk factors. We find significant currency risk exposures in country equity index returns. We then explain these currency betas using several country-specific macroeconomic variables with a panel approach. We find that imports, exports, credit ratings, and tax revenues significantly affect currency risks in a way that is consistent with some economic hypotheses. Similar conclusions are obtained by using lagged explanatory variables, and thus these macroeconomic variables may be useful as predictors of currency risk exposures. Our results are robust to a number of alternative specifications.