Kent Hargis and Jianping (J.P.) Mei
ABSTRACT
In this paper, we develop a new framework in which one can analyze industry and country effects by examining their
underlying return components. We find that the global cash flow factor explains on average 48% of the variation
of industry cash flows and the global discount rates explain 43% of the variation of industry discount rates. These
are more than double the explanatory power of the two factors over country cash flow and discount rate variations,
which are 23% and 13% respectively. This suggests that global factors are much less important for return components
at country level than at industry level. The larger benefits of diversification across countries than across industries
are thus driven more by better diversification of expected returns, although better diversification of cash flows
also drives the result. Moreover, emerging markets tend to have much smaller co-movements of both dividends and
equity risk premiums with those of the world, suggesting a lower degree of integration with the world goods and
financial markets. This appears to be the basis for emerging market diversification.
Kent Hargis
Institution: Goldman Sachs
Jianping (J.P.) Mei
Institution: Stern School of Business, New York University
Email: jmei@stern.nyu.edu
Telephone: (212) 998-0354
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