Regime Dependent Sensitivity of Country Exchange Traded Funds to Common Risk Factors

Abstract

If common factors jointly affect country stock markets, it is an indication of global stock market integration. Common factors may affect some markets more/less than other markets, an indication of the degree of global stock market integration/ segmentation. In this paper, we study the integration of global stock markets based on the returns on exchange traded funds (ETFs) for the US, Canada, UK, Germany, France, Italy, Australia and Japan. The relationship between country ETF returns and common risk factors may be time-varying across countries, and that favors a regime switching (RS) factor model for the dynamics of the country ETF returns. A RS factor model for the relationship between country ETF returns and common risk factors is fitted to daily data for the period from May 31, 2000 to March 31, 2014. We use the data to test a hierarchy of hypotheses on country ETF returns: (1) common factor exposure across all country ETFs and all regimes; (2) common factor exposure across some country ETFs and all regimes, and (3) common factor exposure across some country ETFs and some regimes. The RS factor model for ETF returns fits the data well and the common factors have variable effects across countries and over regimes.

Keywords

country exchange traded funds / common risk factors / regime switching

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2016 Higher Education Press and Brill