Dollar debt and equity returns

ABSTRACT

This article examines the relationship between US dollar-denominated debt and the correlations between the equity markets of 31 countries from 2007 to 2016. Our results indicate that the balance sheet mismatch imposed by the issuance of dollar-denominated debt by foreign firms leads to a common risk factor that extends across international boundaries. These results suggest that dollar-denominated debt should be considered in the design of internationally diversified equity portfolios alongside other factors of economic integration such as trade and foreign direct investment.

KEYWORDS:

• Dollar-denominated debt
• international diversification
• correlation
• comovement

JEL CLASSIFICATION:

• F36
• G11
• G15

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The BIS’s Debt Securities are reported on a quarterly basis whereas our market correlation in Equation 2(2) ${\rho }_{ijt}={\beta }_0+{\beta }_1{D}_{ijt}+{\beta }_2{\tau }_t+{\phi }_{ij}+{\epsilon }_{ijt,}$(2) is annual. Therefore, we utilize the mean of the four quarterly measures of $\frac{d_{ist}}{GD{P}_{it}}$ to calculate $D_{ijt}$.

² The euro is only plotted once per year.

³ These countries are described in Table 2.