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This chapter studies the behavior of international (i.e., emerging and advanced) stock market excess returns, both at the country and sector level, in a dynamic and globally integrated context. A preliminary analysis confirms that emerging stock markets have compensated international investors with generous excess returns and tend to be highly unstable. In addition, the correlation between international stock market excess returns is increasing over time. Preliminary statistics also suggest that emerging stock market excess returns have been largely influenced by the domestic shocks of the late 1990s and early 2000s (i.e., emerging crises). In contrast to existing empirical findings, this chapter shows that financial market liberalizations do not necessarily imply economic integration. Using the R 2 of a multi-(. artificial) model as a robust measure of financial integration and the trade-to-GDP ratio as a measure of real integration, it is shown that (i) there is a delay between financial market liberalizations and de facto integration; (ii) international stock markets are increasingly integrated; and (iii) average excess returns rise as de facto integration rises. The empirical findings of this chapter might have strong implications for the estimation of the cost of capital and the implementation of international portfolio diversification strategies.

AbstractIn this paper, the inventory positions of government security dealers are analyzed for signs of their superior information relative to other participants in the market. Testing the 1966–1980 period on a monthly basis, it does not appear that information on the maturity composition of dealers' positions can be used, either concurrently or when it becomes publicly available, to earn excess returns.

Many financial institutions voluntarily undertake additional interest rate exposure, due to their shortterm funding and the placements of their assets in longer term bonds. Based on realised total bond returns of the major bond markets this paper assesses whether a fixed-income investor is actually rewarded by taking this additional interest rate risk. Unfortunately, the question raised in the title of this article can not clearly be answered. The outcome of the empirical analysis has shown that returns, return volatilities and their correlations are time-varying. However, some investment policy implications and conclusions can be stated, but caution is warranted when interpreting the empirical findings. When various bullet-portfolio strategies are observed a concave (excess) risk/return trade-off pattern can be found. This implies that the efficiency of duration extension is limited. The major government bond and US agency markets do reward interest rate risk, but (excess) returns do not increase linearly with return volatility. Generally, the reward for taking additional interest rate risk is the highest at the front end of the curve, and diminishes as the slope of the excess returns curve flattens from the one-to-threeyear part of the curve. In other words, if a fixed-income investor wanted to obtain higher excess returns by taking more interest rate risk during this long sample period, he should have invested (more) in bonds up to a maturity of approximately two years. Interestingly, the observed excess risk/return trade-off is unstable over time. Different risk/reward patterns that hold across periods are found, and seem to be dependent on macro-economic business cycles. In a bearish interest rate climate, taking additional interest rate risk is not rewarded at all. In these circumstances, a fixed-income investor has a strong incentive to lower the long-run benchmark duration. In addition, it should be noticed that long-duration bonds may be good investments for investors with longduration liabilities. Finally, based on historical interdependencies a fixed-income investor can improve the risk/return characteristics of a bullet treasury bond portfolio with a given interest rate exposure, by allocating the interest rate exposure across maturities and/or international government bond markets. The inclusion of US agency bonds in a US treasury portfolio also improved the risk/return characteristics of the overall portfolio, but to a much lesser extent.

"It is well known that augmenting a standard linear regression model with variables that are correlated with the error term but uncorrelated with the original regressors will increase asymptotic efficiency of the original coefficients. We argue that in the context of predicting excess returns, valid augmenting variables exist and are likely to yield substantial gains in estimation efficiency and, hence, predictive accuracy. The proposed augmenting variables are ex post measures of an unforecastable component of excess returns: ex post errors from macroeconomic survey forecasts and the surprise components of asset price movements around macroeconomic news announcements. These "surprises" cannot be used directly in forecasting--they are not observed at the time that the forecast is made--but can nonetheless improve forecasting accuracy by reducing parameter estimation uncertainty. We derive formal results about the benefits and limits of this approach and apply it to standard examples of forecasting excess bond and equity returns. We find substantial improvements in out-of-sample forecast accuracy for standard excess bond return regressions; gains for forecasting excess stock returns are much smaller"--National Bureau of Economic Research web site