Foreign investors, rebalancing trades, and increases in U.S.-Japan stock market correlations

Foreign investors' transaction volume in the Tokyo Stock Exchange has grown steadily in the past three decades, and Japanese stocks have become a familiar instrument for international diversification. Rebalancing trades in a local national market by foreign institutional investors holding multi...

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Bibliographic Details
Published in:Applied economics 2024-10, Vol.56 (47), p.5634-5649
Main Authors: Imai, Hiroyuki, Kim, Jong-Min
Format: Article
Language:English
Subjects:
Balance of trade
Diversification
dynamic conditional correlations
Economic analysis
Foreign investment
Gaussian copula models
Institutional investments
international diversification
Investors
portfolio rebalancing
Portfolios
Securities markets
Stock exchanges
Stock market correlations
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Summary:Foreign investors' transaction volume in the Tokyo Stock Exchange has grown steadily in the past three decades, and Japanese stocks have become a familiar instrument for international diversification. Rebalancing trades in a local national market by foreign institutional investors holding multi-country asset portfolios, often heavily represented by U.S. stocks, amplify the national market's stock index co-movements with the U.S. This paper examines the extent to which greater participation of foreign investors is associated with increases in the unconditional correlation of daily returns between the U.S. (S&P 500) and Japan (TOPIX). A Gaussian copula marginal regression model is applied to the monthly series of unconditional correlations. We find that the growth in foreign investors' transaction share of the Tokyo market's turnover approximately accounts for the rise in U.S.-Japan correlations for 1990-2019. Foreign investors' trades improve the informational efficiency of local national markets. Increased correlations lead to smaller potential gains from international diversification, however.
ISSN:0003-6846
1466-4283
DOI:10.1080/00036846.2023.2257929