Essays in international finance : risk, jumps and diversification.

Summary This thesis consists of an introductory chapter and three empirical studies that contribute to the international finance literature by examining the dynamics of simultaneous jumps in international stock markets and assessing their impact on international portfolio allocation and financial asset pricing.In the first study, we examine the impact of co-jumps between international stock markets on the demand for foreign assets and the gains from international diversification. Using intraday data from three international indices (SPY, EFA and EEM), we identify a significant number of intraday co-jumps between the three markets considered. We also find that the intensity of co-jumps is particularly high during the 2008-2009 global financial crisis. Furthermore, the application of the Hawkes process shows that jumps tend to propagate from the US and other developed markets to emerging markets. To assess the impact of co-jumps on international diversification, we consider a U.S. investor who chooses his portfolio composition from one domestic risky asset (SPY) and two foreign risky assets (EFA and EEM) so as to reduce his overall portfolio risk. Our results also show that the impact of higher order moments (skewness, kurtosis,.) induced by idiosyncratic and systematic jumps on the optimal portfolio composition is not significant.In the second paper, we address the international equity valuation problem by decomposing systematic risk into continuous and discontinuous components (jumps). We contribute to the financial literature on the explanation of international asset returns by proposing a model with six risk factors. Using intraday data from a set of exchange-traded funds covering developed, emerging and frontier markets, we show that risks of continuous and discontinuous market swings are positively rewarded in the pre-financial crisis period while risks of positive and large jumps are rewarded with a negative premium in the post-financial crisis period. We also show that market price jumps are negatively correlated with volatility jumps, suggesting that price and volatility risks share compensation for the same underlying risk factors.In the third paper, we jointly examine price and volatility jump risks and study the response of international markets to jumps in an aggregate risk factor in both price and volatility. Using intraday data from ten exchange traded funds covering major developed and emerging markets and two volatility indices (VIX and VXEEM), we show that price and volatility jump betas vary over time and exhibit asymmetry between positive and negative jumps. We also show that price and volatility jumps in the market have significant predictive power on future stock returns.