Page 1 of 28
FACTORS AFFECTING INTERNATIONAL EQUITY RETURNS
1.0 Global and Regional Economic Factors
1.1 GDP growth and economic cycles
As factors such as GDP and economic swings have a direct influence on investment strategy and allocation
(Ang & Bekaert, 2022), we need to look back at how they affected the market. These indicators play the
role of the messages coming from the country's economic health, representing fluctuations in trends of
production, consumption, and general economic dynamics (Bekaert, et al. , 2009). Stagnant GDP growth
poses a hindrance to the business sector as during periods of robust GDP growth the businesses generally
experience higher revenues and, thus, a preferred investor optimism and attraction to risk assets
(Aggarwal, et al. , 2020). Although recessions are known for falling GDP growth rates, low spending, and
declining profits figures, these factors make investors run to assets assumed to be safe like government
bonds or defensive stocks (Aloui et al. , 2011). An additional factor is that length and depth of the business
cycles can have a consequence on the mutual fund returns and the allocation of the modern capital market
(Campbell et al. , 2001). For instance, value stocks can beat growth stocks as well during recession and
recovery while the growth stock studios better during boom and expansion (Fama & French, 1992).
Furthermore, industrial sectors like technology and healthcare would evidence more resilience in
comparison to the sectors like manufacturing and construction, which would be in the climax stage in the
case of a financial downturn (Markowitz, 1952). Moreover, global economic interdependence has also
created an increasingly strong correlation between economic statistics and international GDP growth rates
among other economic indicators (Eichengreen & Gupta 2013). Volatility in the global economic
environment tends to affect cross-border trade, exchange of currencies and the market sentiments
pertaining to the financial markets which in turn affects investment opportunities available and the process
Page 2 of 28
of portfolio diversification followed. Hence, investors have to analyze carefully in the growth trends of GDP
and how the economy is set up so they can make right decisions in unstable financial markets.
1.2 Inflation rates and monetary policies
Interest rates, money supply and other monetary policies play a critical role in risk and return of
investments as far as macro economy is concerned (Berger & Pukthmanthong, 2012). Price inflation,
designed to show straight the rising of prices at a general level, indirectly drives the value of currency and
eventually affects the real returns of investments, leading investors change positively among their risk and
return preferences[(Bekaert et al. , 2011). Central banks, being in charge of the effectiveness of numerous
monetary measures, including setting up the rates for loans and bonds and/or planning the final decisions,
aim to reduce the flow of inflation and keep the growth rate of the economy as stable as possible (Bekaert
et al. , 2011). One of the significant effects of monetary policy stance prevailing due to changes in interest
rates is on the valuation of assets, bond yields, and the prices of loans that businesses might incur due to
this (Bekaert et al. , 2011). Under these conditions that are characterized by high inflation rates and
accommodative monetary policy, then some investors allocate to real assets that are likely to present lower
risk of inflation like commodities and real estate (Berger & Pukthuanthong, 2012). On the one hand, at
times of high inflation with trends of high interest rates, investors may turn to a more favorable position of
the fixed-income securities and cash equivalents instead of equities and risky assets (Ang & Bekaert,
2022). Apart from that, the way central banks communicate about interst rates and economic future
perspectives is also of paramount importance as it helps mobilize market expectations and asset pricing
(Bekaert et al. , 2011). There is a particular focus on the central bank statements and speeches in the
market and any indication that a change in interest rates or the policy direction of the bank is being
considered can lead to a market reaction that heavily influences where people decide to place their money
(Berger & Pukthuanthong, 2012). Besides this, the ability to well project bearing and transparency among
Page 3 of 28
central bank actions increases the trust and mood of market players and consequently, they affect the
valuations of assets and the prices of risk. (Bekaert et al. , 2011). As a result, investors may need to keep
track of central bank communications as well as the implication of the announced policy for monetary
policy. The strong ability of the investors to do this will help them be well equipped for volatile investment
markets.
1.3 Interest rate movements and credit conditions
The deviation of interest rates and credit requirements can play a major role in asset prices and charged
credit costs (Bekaert et al. , 2011). Whether the cost of borrowing or the returns on assets, interest rates
are the primary factors that determine the present value of cash flows in the future. Consequently, the
impact of interest rates is felt in the assets' prices across different asset classes (Berger & Pukthuanthong,
2012). For example, if central banks around the world start to raise interest rates, bond prices will decrease
and interest yields go up - this will cause fixed income securities to less attractive in comparison with other
investments (Bekaert et al. , 2009). Furthermore, the reduced liquidity, often symptomatised by tougher
lending criteria and tighter access to credit, can trigger economic activity faltering and profitability slip of
companies thus leading accounted equity attractiveness decrease and market volatility intensification
(Bekaert et al. , 2009). By contrast, an active monetary policy and the presence of sufficiently low interest
rates expanses the terms of borrowing and spends, thus, ascending asset prices and enhancing the
economy (Bekaert et al. , 2011). Therefore, it is essential to keep tab on country's interest rate movements
and credit state in order to assess the investment prospects and manage the portfolio risks accordingly.
Monetary policies and credit conditions are key elements affected by the central banks with decision-
making on monetary policies and regulatory mechanisms (Bekaert et al. , 2011). Through manipulating
policy rates as well as liquidity-increasing measures,central banks are trying to achieve such impact on
macroeconomy as price stability,full employment and sustainable economic development (Berger &
Page 4 of 28
Pukthuanthong, 2012). To what extent do transmission channels of monetary policy - interest rate channel,
credit channel, and other transmission channels - influence the impact of policy changes on financial
markets and domino through the economy (Bekaert et al. , 2011)?Hence, information sources, such as
central banks releases and policy decisions, are given a close attention by investors as they want to have
an understanding on the potential future course of interest rates and their effect on asset pricing and
portfolio diversification (Bekaert et. al. , 2011).
1.4 Commodity prices and terms of trade
Commodity prices and the two-way trade are however the main indexes representing the global trend of
supply and demand of market, significantly affecting the performance of commoditizing markets as well as
the economy of commodity exporting nations (Ang & Bekaert, 2022). This contributes to the growth and
volatility of the different industries such as agriculture and manufacturing, energy, transportation, and
several others (Bekaert et al. , 2009). Furthermore, there are fluctuations in trading terms, which is the
quotation of exports over imports, and this significantly influences the three major features of any economy
i. e. currency, trade balance and national well-being (Bekaert et al. 2009). Goals of a positive TOT (Terms
of Trade) and increasing commodity prices may be met by an increase in the revenue for commodity
producing countries, which will consequently create economic expansion and thrive stock markets in those
particular regions (Bekaert et al. , 2009). However, lower commodity prices and unfavorable terms of trade
somehow can affect commodity-based economies having a direct result on the devaluation of the local
currency, budget distress and foreign capital leaving the country (Bekaert et al. , 2009). Thus the
importance of observing the foreign trade of commodities countries and convenience of trading such
commodities cannot be underestimated in order to determine the performance of commodity related
shares. This then enables one to analyze the economy of those countries exporting the commodities.
Several commodity price determinants exist; some of them are worldwide, industry, and international
Page 5 of 28
geopolitics as well as the macro-economic conditions including demand and supply issues (Bekaert et al,
2009). Take, again, the development of robust economies of the developing countries which cause
commodity demand rise and raise prices (Bekaert et al. , 2009). On the flip side, disturbance of supply
chains, attributed to accidental weather conditions or geopolitical conflicts in the production base comes to
play, resulting in price spikes (Bekaert et al. , 2009). Moreover, monetary policy actions, currency
fluctuations, and investors’ sentiments can also be the major underlying reasons behind short-term caps
and jumps in commodity markets . Consequently, a lot of work is needed to carry out in-depth studies on
supply and demand concepts, geopolitics as well as economical factors so that investment decisions are
made with intense scrutiny into details to succeed (Bekaert et al. , 2009).
2.0 Financial Market Integration and Contagion
2.1 Capital market liberalization and openness
The global financial markets, which were previously very open with a lot of regulations, had undergone a
process of complete liberalization that had previously attracted a lot of criticism on how efficient these
markets are. Buegelsdijk et al. , (2008) show that the a range of IB policies boosted the world's overall
performance (p. 6). Lack of substantial knowledge about workings of the capital flows across borders is a
reason for a more thorough understanding. Carrieri, Errunza, and Hogan (2007) are in favour of the
dynamic nature of market integration process since all sorts of dynamic transformations cannot be
perceived without time involvement; rather market liberalization has to be analyzed in a suitable period.
Subsequent to that, companies having the opportunity to operate in the liberalized regimes are tend to
cross the proverbial borderline to draw up the most efficient modes of business in different regulatory
environments. For example, the enlargement of a market may result in higher competition, increase in
financial opportunities and opportunities to vastly invest into growth, both within and without the boundary
of the market (Beugelsdijk, Smeets & Zwinkels, 2008). To the other side, such entrepreneurs should have a
Page 6 of 28
roadmap for the handling of a regulatory system that is still in transformation or which they may have to
face procedural and governance challenges while transacting in a chaotic economy which point to probable
misfortunes while trading with foreign currencies known for their volatile nature. On the whole, it is
necessary for companies to be in the loop of issues that can be policy, affect them and remedially come up
with the strategies to cope with the risks and take an advantage as well depending on the market
liberalisation. Moreover, to what the extent the market liberalizes and opening of markets that difference
varies for every country. This ends up as a disadvantage of the firms to their rivals and a favour of the
firms growth in these regions (Carrieri, Errunza, & Hogan 2007). Hence, businesses, which are significant
contributors to plural jurisdiction, are required to take dual approaches of Meta-regulation and risk
management; the former being dynamic, while the latter needs to be adjusted to the specific features of a
particular market. Various companies have strongly established their market positions, mastered the
international and regional markets and turned out as leaders over other competitors by observing industry
regulations, building working partnerships with regulatory bodies, and implementing stringent protocols of
compliance.
2.2 Cross-border investment flows and portfolio rebalancing
Capital movements amongst members of the international finance market and actions of the Central Bank
are significant points of the cycle of global finance. As Chava, Gallmeyer, and Park (2015) conclude, the
credit conditions is what mainly affects the stock return predictability showing thus the importance of the
macroeconomic environment to the investment decisions. However, weighted even more French and Fama
noted that the size factor (small), value (cheap), and momentum (trend) determine the returns of the stocks
internationally showing the multi dimensional nature of cross border investments. This understanding is
therefore of great vital for both investors and regulators to be able to foresight market developments and to
minimize the market risks that arise from imbalances in investor portfolios engendered by capital flows.
Page 7 of 28
Today, cross-border investments flock and go around the world, and financial markets also link across
borders; which in turn lead to portfolio diversification and risk management (Chava et al. , 2015). On one
hand, the instability in credit funding causes, for example, change in interest rates or increase of pricing
credit commitments, which affects the decision of asset allocation (Chava, Gallmeyer, & Park, 2015).
Besides those, the role of volume, price, and momentum demonstrates the meaning of factor-based
investing and smart beta management that contributes to a more optimal result across the global market
[Fama & French (2012)]. Policymakers need to monitor consumption, production, credit conditions and
financial markets to estimate if financial systems or they're member institutions are vulnerable and if so,
how (Chava, Gallmeyer, & Park, 2015). Through knowledge of flows, portfolio rebalancing and drivers,
traders are able to make sound judgment in implementation of investment tactics in a way to guarantee
portfolio efficiency and reach their investment goals (Fama & French, 2012). Moreover, the governmental
authorities can provide the appropriate regulations to create financial integrity and thereby avoid the
negative impacts on the economy (Chava, Gallmeyer, & Park, 2015). In this period of economic unrest that
occurs during the COVID-19 pandemic when cross-border investments play a crucial role in
macroeconomic and financial stability as the effects induced can be dire, it is imperative to properly grasp
the cross-border investment dynamics and to implement effective portfolio rebalancing strategies (Sandoval
& León, 2020). The COVID-19 pandemic had a role in revealing interconnections between the world
markets, which requires risk control policy so as to confront the volatile nature of the economic conditions.
2.3 Financial crises and systemic risk transmission
Financial crises and financial institutional problem reflected dark side of global capital markets.
Christiansen and Ranaldo (2009) argued for a global portfolio view to mitigate the impact of extreme
events, emphasizing the need for diversification across geographical regions and asset classes. Moreover,
both Chiang and Zheng (2010) observed that the stock markets globally did behave like herds and such
Page 8 of 28
behavior might make market contagion more likely during times of crisis. This therefore imposes on the
government to design a tight regulatory regime that promotes the stability of the market and minimizes the
chain reaction of systemic risk transmission across the boarders. The 2008 global financial crisis was a
realisation of the complex interdependence of financial markets and the speed of contagion risks
transmission across borders (Claessens et al. , 2013). During the crunch time, the lay out of the domino
effect to include the swift spread of the uncertainty from Unite States to other regions and widespread
disruptions in global financial markets (Claessens et al. , 2013). On top of that, it showed how crucial was
the collaboration among regulatory authorities and monetary institutions in order to have the possibility to
regulate the risks linked to the system and to guarantee the stability of the financial markets (Claessens et
al. , 2013). In response of the crisis, the IMF and the FSB, two international organizations, have promoted
the adoption of international updates in information sharing, and cross-border collaboration to deal with the
financial crisis in the global market. Through the introduction of regulations – the Basel III framework, for
example – the global banks have been made stronger and the possibility for future financial crises has
been reduced (BCBS, 2017). The major issue in implementing international coordination of regulation
exists in fact that the jurisdictional domains of regulation diverge and thus no one has the specific power
among all of them to proclaim risk management strategies (IMF, 2020). It is vital to keep an eye on
systemic risks and put preventive measures in place which ultimately are meant to maintain the global
financial stability. With a focus on regulatory improvement and the further progression of international
cooperation, policy makers can reduce financial crises effect and the systemic risk transmission impact at
the global scale (Claessens et al. , 2013).
2.4 Herding behavior and investor sentiment
The occurrence of financial crises and cross-border risk shocks bring home the fact that the financial
system is an interlinking system. According to Christiansen and Ranaldo (2009) a portfolio view taking into
Page 9 of 28
account the whole globe is much more effective in case of such kind of black swan events. The authors
highlight the fact that in this kind of situation a diversification of geographical and investment regions
portfolio with assets selection among different classes will serve as a hedge. Similarly, in their study,
Chiang and Zheng (2010) evidenced the herd behavior’s presence in the global stock market, and one may
wonder if it could be a powerful effect during the times of crisis. Consequently, policy makers must embrace
economic policies that will lead to the formation of stronger regulatory frameworks for the growing
resilience of the market as well as the minimization of systemic risk transmission across the borders. The
interdependent financial system was dramatically exposed by the 2008 financial crisis, as evidenced by
Brunnermeiera (2009). Lehman Brother's downfall just in the USA was enough to cause a chain reaction of
fear and shortage of money supply in other parts of the world (Shin, 2009). This crisis made clear the
strong part of financial institutions played as a result of increased linkedness and risks communicating at
high speed through some complex financial products and balance sheets (Claessens et al. , 2010). Along
with that, the crisis revealed the underlying incompetency of regulatory oversights and risk management
methods and which ended up demanding for a complete reforms of what is needed to hold the global
financial system in place (Reinhart & Rogoff, 2009). As a result practice, regulatory authorities started to
introduce efforts in increasing capital requirements, improving risk disclosures and also strengthening of
institutions control over systemic ones(Brunnermeier et al. , 2016). Eventually the international
collaboration activities, such as such as the Basel III structure and the Financial Stability Board framework,
have been aimed to harmonize of the regulatory standards as well as address the cross-border spillover
effects (Basel Committee on Banking Supervision, 2010). Although certain measures were undertaken, the
complication of governing and handling the systemic risks in interconnected and global financial markets
has continued to affect their operation (Acharya, Dell'Ariccia et al. , 2011). Hence policymakers and market
players must remain alert and proactive while continuously watching out for evolving risks and ensuring
graduality or alleviating their impact to maintain financial stability (Duffie, 2010).
Page 10 of 28
3.0 Political and Regulatory Environment
3.1 Political stability and government policies
The level of stability in the political system and how the government policies are made around the world are
so important for the investment climate building. Ferreira and Gama (2005) in discussion paper on
dynamics of country risks including industries and world politics imply that risk management in business
needs to be flexible to changes in political and business regulation models. They concluded that, policy
shifts alone can result in notable fluctuations in the risk levels of four main asset classes, which include:
stocks, bonds and two others. In addition, Gelos and Wei (2005) emphasized the role of transparency in
foreign investors' holding of portfolio, directing investors into the areas where political stability, or regulatory
clarity, attracts foreign assets. In fact, decision-makers need to give this matter priority elucidation and
establishment of peace and order to build investors' confidence and thereby draw in capital flows. Political
stability is in essence the most vital determinant of attractiveness of investment (Aisen &VEiga, 2013). At
the country level, stability in the political system and policy making are major factors that reduce the risk of
investors as they regard the country as less risky (Dreher & Herzfeld, 2005). Economic entities active in the
respective countries will enjoy a steady political environment they prefer for stabilizing in the long-run. They
are free from bumpy policy changes, sudden appropriation risks, and political upheavals (Knack & Keefer,
1995). Additionally, another factor which cannot be underestimated is the role of government policies
through fiscal, monetary and financial regulations which directly influence investor sentiment and market
dynamics (Cihak & Demirgüç-Kunt, 2013). An illustration could be government's increasing fiscal policies
that lead to increased economic growth but there will be eventual boost in investor confidence and
enhanced equity market performance (Poterba & Summers, 1988). For example, if it is hard to get approval
for business by the relevant bodies, or if there is political uncertainty, investors may lose their confidence
and pull out of investing (Brooks et al, 2003). Subsequently, it falls on the policymakers’ shoulders to
formulate and implement prudent fiscal and monetary policies along with provision of political stability for
Page 11 of 28
making investment climate an attractive one (Edison et al. , 2002). Besides transparency in the government
decision-making process and the regulatory framework which also creates investors` confidence and
certainty over investment (Kaufmann et al. , 2010). Policy-transparency assists in doing risk assessment
better and makes investing more trustworthy. Investors are then able to decide which investments to make
and which to not ( Svensson, 2003). In addition, bureaucratic transparency is a factor that serves to
minimize the possibilities of bribing and favoring one side over the other which lead to establish a an equal
field of play for the domestic and foreign markets.
3.2 Corporate governance and investor protection
As the pillars of fair and orderly market, corporate governance and investor protection play an instrumental
role in maintaining the integrity of the market and boosting investor trust. Fidora et al. (2007) took an
investigation of home bias in the markets of global bonds and equities where they indicated the sphere of
corporate governance standards which diminish the endeavor of investors to domestic assets. The investor
protection regime can help in reducing the imperfections of the market; it can also reduce information
asymmetries as has been highlighted by (Griffin & Stulz, 2001) . Hence failure of the market to provide
safeguards for individuals' investment interest and investors should be the issue to be addressed by the
regulators as well as the creation of corporate governance frameworks to ensure the development of the
capital market. Corporate governance as the overall framework consisting of procedures and methods that
form a company's decision-making and accountancy processes is made clear by Monks and Minow (2008).
The governance of corporations which are good performs the role of serving shareholders and
stakeholders in the best interest (Shleifer & Vishny, 1997). In real terms, corporate governance refers to
directors composition, the executive remuneration, the shareholders' interests, among others (La Porta et
al. , 2000). For instance, the constitutions of the independently regulated boards and the proper
mechanisms for the supervision of the board eliminate the possibility of inherent conflicts or even
Page 12 of 28
managerial opportunism (Bhagat&Black, 2002). In the same manner, clear financial reporting and prompt
information disclosure of the circumstances and facts that might touch their investments make the investors
feel safe and help the market be transparent (Leuz et al. , 2003). Regulator schemes that include legal
frameworks, regulatory supervision, and implementations of solid enforcement mechanisms are key in
ensuring the rights of investors. Comprehensive legal regulations, preventing the situations of insider
trading, fraud and market manipulations help to uproot these phenomena and to regulate fair and
adequately ordered markets (Licht et al. , 2005). Furthermore, the regulatory authority part is also very
important and it is enforcing compliance with corporate governance standards and shareholder protection
rules (Coffee, 2006). With supervision of the firms' practises to be exercised and corporate transparency
ensured, regulators would be able to create a free-market environment and consequently a positive aspect
of this would be investor confidence which facilitates capital formation and sustainable economic growth
(Ferris et al. , 2003).
3.3 Trade policies and regional agreements
The role of world trade policies and regional agreements as an initiator of global socio-economic
mechanisms and investment dynamics cannot be neglected. Harvey (1995) emphasized the effect of trade
policies on forecastable risks involving returns from emerging markets. He worked within the stochastic
monetary framework. Next, there is a regional trading agreements which are referred to by Ferreira and
Gama (2005) can be a reason for the country and border investment. The comprehensibility of the
influence over policies in trade is necessary In order to make most of opportunities in the market and avoid
the stars of the perils caused by geopolitics and trade rejecting. Trade policy can be ascribed to procedures
adopted directly by governments with the aim at modifying international flows of commodities and services
(Bagwell & Staiger, 2002). These foreign policy decisions include interest rate, tariffs, quotas, subsidies and
trade agreements which are used to promote domestic markets, protect the intellectual property rights as
Page 13 of 28
well as creating equal competition in the international marketplace (Rodrik, 1995). Trade policies makers
alterations may have huge impact cutting on international trade volumes, supply chain cooperation and
market access for the businesses (Bown, 2018). As instance, the erection of barriers or identical charge
rates to one country could bring negative reaction from other countries, the trade flow and routes will not
run smoothly (Gawande et al. , 2012). Although regional trade agreements like NAFTA and EU eliminate
tariffs, harmonize regulations, and are promoting economic cooperation by eliminating customs duties,
North American Free Trade Agreement (NAFTA) and European Union (EU) accelerate trade and
investment among member countries (Baldwin & Jaimovich, 2012). These pacts ,in turn,turn out to be the
basis for the businesses to access to the markets which is large,to have their input at the production and
to be competitive(Limao & Venables, 2001). Even though they remove trade barriers and tariff
discrimination, they also have challenges such as regulatory consistency, market access and trade
disputes (Finger & Nogues, 2002). Investors need to keep our eyes open for the different changes in trade
policy, assess all possible impacts of these changes on the market dynamics, the competitive advantage of
the different industries, and the investment chances. (Helpman & Krugman, 1985). Investors may obtain
beneficial information on trade policies and regional agreements that will assist them to perceive upstream
trends and quell the risks as well as take advantage of new market prospects in international markets when
investors well informed.
3.4 Taxation and regulatory changes
Taxation and regulatory adjustments constitute a substantial part of investors final choices and the resulting
investment portfolio performance. Choi and Stulz (2001) had the findings from their research that show
stock returns in the capital markets getting directly affected by Regulatory change caused by International
competition and currency rate shocks. In addition to that, Ferreira and Gama (2005) determined, the
regulatory framework changes mould the risk-returns not only in BUT BETWEEN the international markets.
Page 14 of 28
Accordingly, it is crucial for policymakers to find delicate equilibrium between negative effects in financial
markets and effectiveness with the aim of securing dynamic growth and investor trust. The practice of
taxation covers a pretty large territory that includes the introduction of forms of generating revenue,
redistribution of wealth and control of economic behavior (Slemrod 1990). The government interference is
expressed in such policies as taxes on corporate income, taxes on individuals, capital gains taxes and
taxes on consumption (Auerbach & Slemrod, 1997). Important swings in tax rates, tax credits, and tax
treaties could impact in the way investment decisions are made, corporate profitability, and capital
allocation (EPU, 1994). For illustration, cuts in the corporate income tax rates might bring about companies’
investment in their businesses and boost their stocks, whereas, raises in the capital gains tax may deter
investors to sell their assets and encourage market fall (Poterba, 1987). Regulatory measures, imply
amendments of the norms, specifying the financial markets, corporate governance and the investors
protection systems (Rajan & Zingales, 2003). Such adjustments may occur due to either the transformation
of political atmosphere, changes associated with market conditions, or the reaction to financial
misdemeanors and scandals (La Porta et al. , 1997). Regulatory reforms may inclose increased market
transparency, the trust process and in the security risk minimization (Diamond & Rajan, 2009). On the other
end, over conventional regulations or regulatory problems can impose stifling innovation, deter investments
and bring the market efficiency to a halt (Levine, 200). Consequently, the politicians must effectively tailor
purpose, calmly tax, and proper regulation policies to make sure the objectives are achieved while not
having an adverse effect on the market's participants and the economy (De Mooij & Ederveen, 2003).
4.0 Currency Dynamics and Exchange Rate Risks
4.1 Currency movements and volatility
Movements and fluctuations of the currency and the country exchange systems are prime matters that
global investors and policymakers are concerned about. Hau and Rey (2006) studied at length the role of
Page 15 of 28
exchange rates in the fluctuations of equity prices and those of capital flows, and revealed the dynamics
behind the factors that drive prices up and down. Not only so, Rossena and Satchell in 2005 came up with
the GARCHX models which help to capture the cross-sectional movement of currency and therefore
providing more insight the complex dynamics of the movements in currency market. Many trade,
investment flows, geopolitical happenings and economic competition are impacted greatly by monetary
movements and determining factors such as interest rate differentiation, inflation rates and geopolitical
events. Exchange rate volatility, which is a measure of price fluctuations in currencies, offers a way to
gauge the level of uncertainty and the risk associated with exchange rate movements (Engel, 1996).
Instability of the exchange (appreciation and depreciation) can elevate the transaction cost, push for the
market participants uncertain with the future exchange rate, and spread the instability in the financial
market (Chen, Weill, Corbett and Chung, 1989). For the global business multinational corporations (MNCs)
exchange rate variations can affect the profitability due to the translation of revenue from foreign currencies
to domestic ones, depress the competitive position of export market-oriented industries and directly affect
consumers purchasing power (Fratzscher, 2006). Consequently, monetary authorities and central banks
tend to respond to exchange rate fluctuations through interventions to essentially stabilize the foreign
exchange markets, potentially curb volatility, and facilitate macroeconomic stability. Currency risk
management techniques like applying forward contracts to exchange options can be used in order to
minimizing sway of adverse currency movements on portfolio returns (Jorion, 1992). Through utilizing
foreign exchange market tracking tools, analyzing macroeconomic parameters, and implementing
appropriate risk management schemes, investors can effectively cope and even take advantage of volatile
currency events by being among those with the necessary knowledge of this activity (Baillie & Myers,
1991).
Page 16 of 28
4.2 Foreign exchange intervention and reserves
The bias that central banks use to stabilize the currency and manage the economic bumps through the
intervention in the foreign exchange market and reserves are tools applied. Based on the investigation by
Hou et al. (2011) on the factors responsible for the performance of global stock market, intervention in
foreign exchange and how it may control inflows of capital was also evaluated. Additionally, Johnson and
Soenen (2003) investigated the connection between economic assimilation and inter-market stock
comovement, emphasizing the adverse impact of civilian powers on financial inner transaction. Central
banks’ intervenes in the transaction of foreign exchange reserves can affect the currency stability of a
country and it can also raise the investor confidence in the global financial markets. Foreign exchange
intervention is the name of the actions which central banks take to purchase or sell currencies in the fx
market to influence the speed of exchange rates and market's smooth function (Edson & Melvin, 1990).
Central banks embark on purchasing or selling the domestic currency to the degree needed to stem the
development of excessive volatility in the foreign exchange market; prevent a currency exchange rate
overshooting in the upward or in the downward direction; or in many cases this is a tool to attain certain
monetary policy objectives (Fratzscher, 2012). Sovereign wealth funds which are made up of currencies
from different countries, gold, and other support in odvertnaya shocks and stabilization of money, as well
assist in meeting financial obligations of a country (Jeanne & Ranciere, 2011). The central banks are
specialized in proactively dealing with their foreign reserve currencies with an objective of maintaining
liquidity, reducing risks of inflation, and having enough money for foreign payments. The size and
composition of the foreign reserve can serve as a marker of that central bank’s resolve for exchange rate
stability, its reputation in monetary policies and the confidence of the financial market (Jeanne and
Ranciere, 2011). Foreign exchange intervention and the management of reserves become the keys to
macroeconomic stabilization, to restore confidence in investors and provide the platform for sustainable
growth of a tightly associated global economic system that we live in (IMF, 2016).
Page 17 of 28
4.3 Purchasing power parity and deviations
Deviation and thinking from purchasing power parity (PPP) are basic concepts for one to understand
currency evaluation and how they impact international trade. Huang et al. (2011) analyzed agency risk,
overconfidence and gap of PPP in listed companies in China, disclosing related effects among investment-
cash flow behavior. Moreover, Jin (2012), alternatively, focused on the ownership structure of the firm and
its relationship to an idiosyncratic risk which complicates the assessment of investment risks factor within
different ownership structures depending on PPP (Private Public Partnership). To make cross-border
investment decisions, investors must account for differences in risk and reward between the PPP rule and
the impact of currency fluctuations on portfolio stability. The concept of purchasing power parity (PPP)
implies that if the parities of exchange rates are equal for each of the countries the buyers who are
purchasing goods from these countries will have the same purchasing power (Rogoff 1996). Misalignment
between the exchange rate and the price levels of the countries could be one of the causes that make the
real preferences-cost conditions differ in two countries (Engel & Rogers, 1996). However, they might be the
result of different reasons like in the case of the inflation rates or the transaction costs and the market
frictions (Taylor, 2002). In the case, the PPP fails to be true, currencies can be either overvalued or
undervalued as compared to their equilibrium value what may directly or indirectly effect the trade flows,
capital movements, and investment decisions (Dornbusch, 1992; Rogoff, 1996). Investors and the
authorities watch deviations in PPP to determine currency misalignments, come up with an exchange rate
adaptation strategies, and manage currency risk in the international portfolios, as provided by Gourinchas
and Rey (2007). Taking into consideration the PPP deviations investors can alter their portfolio allocations
in a way that such diversification helps to take advantage of the currency appreciation or depreciation
opportunities and also protects the portfolio performances from swing of the exchange rate volatility rises
(Hodrick, 1987). PPPs determination and variation comprehension becomes key to well-informed
investments in the global financial markets.
Page 18 of 28
4.4 Currency hedging and exposure management
Hedging using currency and exposure management mechanisms can be critical strategies to be deployed
for the management and maintenance of currency risk in international portfolios. The exchange rates
linkage with equity prices, on the one hand, and capital flows, on the other, reveal the importance of
currency hedging to achieve the best possible return on investment. Contributorily, Huang et al. (2011) also
paid attention to agency costs and investment-cash flow sensitivity in Chinese listed companies, with that
confidence needed for currency exposure management hinged on effectiveness. This is achieved by the
hedging strategies having strong defense mechanisms ready to be activated to fortify investors' global
investment portfolios against the adverse currency moves. Currency hedging is concerned with an
economical means involving instruments such as forward contracts, options, as well as currency swaps for
smoothing out exacerbation as a result of exchange rate variations on income from investments (Bartram &
Bodnar, 2007). Hedging aids the investors align exchange rates and the home country currency to avoid
the vulnerable volatility of their foreign investment valuation (Froot & Stein, 1991). Furthermore, currency
exposure management strategies go beyond the natural hedging approach with the aim of achieving
maximum returns coupled with minimizing the impact of FX risks (Jorion, 2000). Currency diversification
implies having counterbalancing currency-denominated assets/liabilities to ensure a foreign exchange risk
hedging (Dominguez & Tesar, 2006). Currency diversification is thought of as diversification of assets into
those that are denominated in currencies other than one's own (Levich & Thomas, 1993). Strategic asset
allocation involves adjustment to portfolio weights according to forecasted currency movements and market
conditions as long as these adjustments are done in a way they achieve risk-adjusted returns (Brennan
1979). Investors could be able to cover their bases so to say by mixing these approaches. They can, in so
doing, suit their investment objectives and risk factors to their preferences. Moreover, continuous currency
exposures monitoring and rebalancing from time to time are the imperative steps towards dealing with
morphed market conditions that change the risk-return ratios (Jorion, 2003). As a matter of fact, the
Page 19 of 28
effective handling of currency mechanization and hedging are the component parts of a generalized risk
management framework for international portfolios.
5.0 Industry and Firm-Specific Factors
5.1 Industry competitiveness and market structure
Industriyal competition level and firm market structure (5. 1) ćiv vital weapons which cause to either strong
and high performance of company or investors’ negative sentiment. In their research, Pastor and Veronesi
(2003) analyzed stock valuations and the relationship between profitability and investors’ expectations
while keeping in mind the importance of industry dynamics in shaping the dynamics of profitability (Shlomo
and Margit 2003). And Rouwenhorst (1999) did the other research on the local return factors and the
turnover rate relationship in developing country stock markets, focusing on the impact of the market
structure on the actions of market participants and on market efficiency. Analyzing the rivalry of entry and
existing players is a must-have for investors to find the most prospective investment opportunities with the
goal of assessing the potential of companies in the chosen industries. Competitiveness of industry shows
how intense the rivalry in an industry can be, which helps in maintaining pricing strategies, profit margins
and innovations among the firms (Porter, 1980)In highly competitive industries, companies face heightened
hostilities among competitors, market newcomers, and powerful buyers and sellers (Porter, 1980). Then,
the number competition might be few of it either in monopolistic or oligopolistic industries, allowing firms to
yield higher control on prices and market dynamics (Tirole, 1988). Market structure meanwhile is the
organization or the nature of market. For example, the market structure is the number of firms, entry
barriers, and product differentiation (Bain, 1956). In contrast, competitive markets are assisted by many
small companies in low barriers of access as sources of innovation and efficiency (Bain, 1956). Indeed, the
kind of markets where there is a small number of big companies that are left with a small competition can
sometimes result in prices that are extremely high and a low consumer welfare (Posner, 1975). For this
Page 20 of 28
reason, investors study the industry as regards its competitiveness and market structure to determine the
probability and magnitude of risk and opportunities particular to certain sectors (Barney, 1991). Using the
findings of their analysis on competitors’ dynamics as well as the market conditions, investors can better
choose their portfolio allocations and grow their risk controlling strategies (Barney, 1991). In addition, an
industry's competitiveness and market structure have a significantly impact on a firm's goal, tactics as well
as the dominant strategy which affects the firms' performance and shareholder value.
5.2 Corporate earnings and profitability
Investor returns and stock valuation can be considered as two key properties that are propelled inherently
by the magnitude of corporate earnings and profit. “The role and responsibility of different agents of a
financial market – managers and banks – have been explored by Shleifer and Vishny (1997) in a rather
detailed survey which aims at explaining the link between corporate governance and high profitability.
Rapach, Strauss, and Zhou (2013) provides further evidence on predictability of stock returns around the
world by highlighting relation between corporate earnings and global equity market efficiency. Investors
shall use up-to-date profitability assessments of the companies to formulate the appropriate investment
purposes and carry out the capital allocation among sectors or markets. Earning prices are the total income
that a company gets from condition of operations, and they perceive the company's revenue-generating
and cost-managing capability (Graham & Dodd, 1934). Secondly, profitability, a financial ratio that is
precise in illustrating the efficiency of a business in making profits over costs and investments (Titman &
Wessels, 1988), reflected an effective management. Strong outcome of profitability tilted to effective
management formulation, competitive advantages, and robust financial position which are ideal investment
characteristics meant for investors who want stable returns and long term growth. Our argument is proved
on the other hand; when shrinking income points to inefficieny at operation, pressure from the competition
and not favourable market conditions that influences a corporate actualization as well as the investors
Page 21 of 28
opinion (Barney, 1991). In this respect, investors keep their eyes peeled on corporate earnings and
profitability metrics like earnings per share (EPS), return on equity (ROE), and profit margins to gauge the
financial health and indicator of the individual companies, sectors as a whole (Graham & Dodd, 1934). The
corporate trends in earnings and profits can help in knowing whether the broader economy is healthy and
the trend in market sentiment. The results are the reflection of these trends in investment strategies and
proportion in the allocation of assets (Titman & Wessels, 1988). Through applying a strategy which
employs earnings and profitability of company’s analysis into their investment process, the investor can
form a clearer picture of the possibility of creating value and risk assessment based on earnings volatility
and business cycles (Porter, 1980).
5.3 Mergers, acquisitions and corporate events
The instances of mergers, acquisitions, and takeovers this creates on the value of firms and can have an
influence on market mood. In their paper "Determinants of Cross-border Equity Flows" and in their focus on
the events in companies which drive international capital movements, Portes and Rey (2005) analyzed.
The knowledge of why and how corporate events take place will fill in the investor's strategic plan as a tool
to be used when predicting the market's behavior and making adjustments needed to deal with changes in
market circumstancesM&A, divestitures, spin-off and restructurings act corporation particularly in the
matters needed to the firm; such events can accelerate or stabilize corporate operations, financial position
and stock market value (Mitchell & Mulherin, 1996). For instance, acquisition deals may lead to the creation
of synergies, increased market size, and reduction of costs, thereby enabling higher shareholder value, and
level of stocks (Andrade et al. 2001). Preferably, she can differentiate among their successes – good or
bad – and (Jensen, 1993) which implies that such considerations weigh down on the value of the
company’s shareholders. Corporations' events also relate to the corporate strategies or management
effectiveness, and signals may be sensitively implied either from polls of the existing customers to the
Page 22 of 28
transactions data, which will change investors' behavior (R. Loughran & D. Vijh, 1997). Furthermore, the
effect of regulator changes on the deals, namely those in the antitrust law field or concerning the
accounting standards, can have a great impact on the realistic prospects of corporate negotiations and their
profitability as well, shaping a firm's strategic decisions and making the market more competitive (Brigiam,
& Houston, 2009). Along with this, adjoining corporate gatherings, sometimes trigger building adjustments
in the investment portfolios of investors as they reassess risk and return profiles, industry exposures, and
growth prospects (Mitchell & Mulherin, 1996). As a result, knowing about the business reports, their
determinants, and their possible results among investors is a crucial information to investors the decisions
they make, the risks they manage, and the chance they have (Bruner, 2004). Through the study of
corporate actions' drivers, and assessing consequences for these soft factors for firms and markets,
investors may improve their capabilities of generating excess return relative to investing benchmarks over a
longer time horizon (Portes and Rey, 2005).
5.4 Management quality and corporate governance
Sufficient Management competence and corporate governance seriousness are obligatory conditions for
firm durability and sustaining shareholder value. Stulz (2005) was author of a very successful book that
deeply delved into the constraints imposed by financial globalization, contrasting sharply with the crucial
role played by corporate governance system in safeguarding the system. By having working systems of
governance in place, not only market externalities are neutralized but stability and corporate trust are also
added in the economy. In today’s society, interconnected and quicker global economy puts heavier
responsibility on companies than before. Hence, it is becoming more vital to have strong corporate
governance standards. However, the companies are involved non-linear complexity in the societies as the
facilities get spread and they have to deal with different stakeholders. Thus, they have to pay great
attention to management and leadership. Sunk and Zuo (2019) turned their attention to the comparative
Page 23 of 28
valuation of global equity portfolios and it was their findings that showed how the evaluation and allocation
of equity portfolios are highly influenced by management quality. Investors look into the corporate
governance regimes to assess the probability of managerial wrongdoing, conflicts of interest and a
company that will be driven into oblivion. The companies with the strong internal framework of the
governance are seen as trustworthy and therefore negotiable with the investors’ interest growing up and
their market value increasing. Also, establishing more principals of transparency and accountability, these
means can be taken as the basis of shareholders, managers, and other stakeholders achieving their
aligned interests which in the long run will help to reduce agency costs and increase value creation. The
theorists Shleifer and Vishny, in 1997, confirmed a hypothesis that quality of company management and
financial transparency is important, increasing company profitability. Companies with distinct and
independent reporting structures, risk-proofing mechanisms and well-thought-out procedures are more
agile in stressful times and seize the opportunities that suddenly arise. Executive committees which have
the responsibility of supervising managers, ensuring the protection of shareholders simultaneously setting
the stage for good conduct, are at the top of the pyramid. Stulz made an argument that the government
failures can result in market inefficiency and systemic risk, therefore we need to be concerned with the
quality of governance and need to follow it up. With reputation and trust being pillars of today's business
environment, the ones who follow good governance are likely to sustain even the biggest turbulences and
afford growth return to their shareholder groups in the long run.
Page 24 of 28
6.0 References
Aggarwal, R., Ren, L., & Singka, C. (2020). Do economic and financial integration lead to global portfolio
holdings? Journal of International Money and Finance, 109, 102248.
Aloui, R., Aïssa, M. S. B., & Nguyen, D. K. (2011). Global financial crisis, extreme interdependences, and
contagion effects: The role of economic structure? Journal of Banking & Finance, 35(1), 130-141.
Ang, A., & Bekaert, G. (2022). International asset allocation with regime shifts. Review of Financial Studies,
15(4), 1137-1187.
Bekaert, G., Harvey, C. R., Lundblad, C. T., & Siegel, S. (2011). What segments equity markets? Review of
Financial Studies, 24(12), 3841-3890.
Bekaert, G., Hodrick, R. J., & Zhang, X. (2009). International stock return comovements. Journal of
Finance, 64(6), 2591-2626.
Berger, D., & Pukthuanthong, K. (2012). Market-wide liquidity, cash flow risks and expected returns.
Journal of Financial Economics, 104(1), 166-183.
Beugelsdijk, S., Smeets, R., & Zwinkels, R. (2008). The impact of international business rules on firm
performance. International Business Review, 17(3), 256-273.
Carrieri, F., Errunza, V., & Hogan, K. (2007). Characterizing world market integration through time. Journal
of Financial and Quantitative Analysis, 42(4), 915-940.
Chava, S., Gallmeyer, M., & Park, H. (2015). Credit conditions and stock return predictability. Journal of
Monetary Economics, 74, 117-134.
Page 25 of 28
Chiang, T. C., & Zheng, D. (2010). An empirical analysis of herd behavior in global stock markets. Journal
of Banking & Finance, 34(8), 1911-1921.
Christiansen, C., & Ranaldo, A. (2009). Extreme events and the global portfolio view. Journal of Banking &
Finance, 33(12), 2209-2226.
Desrochers, P., & Urata, S. (2014). Trade and globalization: An introduction to regional trade agreements.
Edward Elgar Publishing.
Fama, E. F., & French, K. R. (2012). Size, value, and momentum in international stock returns. Journal of
Financial Economics, 105(3), 457-472.
Ferreira, M. A., & Gama, P. M. (2005). Have world, country, and industry risks changed over time? An
investigation of the development of the international stock and bond markets. Journal of Empirical
Finance, 12(4), 513-544.
Fidora, M., Fratzscher, M., & Thimann, C. (2007). Home bias in global bond and equity markets: The role of
real exchange rate volatility. Journal of International Money and Finance, 26(4), 631-655.
Gelos, R. G., & Wei, S. J. (2005). Transparency and international portfolio holdings. Journal of Finance,
60(6), 2987-3020.
Griffin, J. M., & Stulz, R. M. (2001). International competition and exchange rate shocks: A cross-country
industry analysis of stock returns. Review of Financial Studies, 14(1), 215-241.
Harvey, C. R. (1995). Predictable risk and returns in emerging markets. Review of Financial Studies, 8(3),
773-816.
Page 26 of 28
Hau, H., & Rey, H. (2006). Exchange rates, equity prices, and capital flows. Review of Financial Studies,
19(1), 273-317.
Hou, K., Karolyi, G. A., & Kho, B. C. (2011). What factors drive global stock returns? Review of Financial
Studies, 24(8), 2527-2574.
Huang, W., Jiang, F., Liu, Z., & Zhang, M. (2011). Agency cost, top executives' overconfidence, and
investment-cash flow sensitivity: Evidence from listed companies in China. Pacific-Basin Finance
Journal, 19(3), 261-277.
Hwang, S., & Satchell, S. E. (2005). GARCH model with cross-sectional volatility: GARCHX models.
Applied Financial Economics, 15(3), 203-216.
Jin, X. (2012). Firm ownership and the idiosyncratic risk of returns. Journal of Finance and Quantitative
Analysis, 47(3), 657-683.
Johnson, R., & Soenen, L. (2003). Economic integration and stock market comovement in the Americas.
Quarterly Review of Economics and Finance, 43(3), 527-547.
Karolyi, G. A., & Stulz, R. M. (2003). Are financial assets priced locally or globally? In G. M. Constantinides,
M. Harris, & R. M. Stulz (Eds.), Handbook of the Economics of Finance (pp. 975-1020). Elsevier.
Kim, J. B., & Shi, H. (2011). IFRS reporting, firm-specific information flows, and institutional environments:
International evidence. Review of Accounting Studies, 16(3), 474-517.
Kumar, L., & Tsetsekos, G. P. (1999). Identifying risk factors in emerging markets. Financial Analysts
Journal, 55(5), 41-50.
Page 27 of 28
Lau, S. T., Ng, L., & Zhang, B. (2010). The world price of home bias. Journal of Financial Economics, 97(2),
191-217.
Lee, J., & Strazicich, M. C. (2003). Minimum Lagrange multiplier unit root test with two structural breaks.
Review of Economics and Statistics, 85(4), 1082-1089.
Lesmond, D. A. (2005). The costs of equity trading in emerging markets. Journal of Financial Economics,
77(2), 411-452.
Longin, F., & Solnik, B. (2001). Extreme correlation of international equity markets. Journal of Finance,
56(2), 649-676.
Moerman, G. A. (2008). Diversification in euro area stock markets: Country vs. industry. Journal of
International Money and Finance, 27(7), 1122-1134.
Ng, D. (2004). The international CAPM when expected returns are time-varying. Journal of International
Money and Finance, 23(2), 189-230.
Pastor, L., & Veronesi, P. (2003). Stock valuation and learning about profitability. Journal of Finance, 58(5),
1749-1789.
Portes, R., & Rey, H. (2005). The determinants of cross-border equity flows. Journal of International
Economics, 65(2), 269-296.
Rajan, R. G., & Zingales, L. (2003). The great reversals: The politics of financial development in the
twentieth century. Journal of Financial Economics, 69(1), 5-50.
Rapach, D. E., Strauss, J. K., & Zhou, G. (2013). International stock return predictability: What is the role of
the United States? Journal of Finance, 68(4), 1633-1662.
Page 28 of 28
Rouwenhorst, K. G. (1999). Local return factors and turnover in emerging stock markets. Journal of
Finance, 54(4), 1439-1464.
Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. Journal of Finance, 52(2), 737-783.
Solnik, B., & Zuo, L. (2019). The relative valuation of global equity portfolios. Financial Analysts Journal,
75(3), 78-93.
Stulz, R. M. (2005). The limits of financial globalization. Journal of Finance, 60(4), 1595-1638.
