The structure of international stock returns and the integration of capital markets

This paper investigates the structure of international stock returns in Europe and the U.S., and examines whether international capital markets are integrated. Using data on 6000 firms in the U.S. and twelve European countries from 1978 to 1990, we find evidence that countries share multiple risk factors. We test whether capital markets are integrated by examining the pricing of country indices and comparing the prices of factor risk across countries. Our tests support the hypothesis that capital markets in our sample are internationally integrated in the sense that the rewards for risks are identical across countries. However, we find a widespread size effect that is uncorrelated across countries. This finding provides international evidence against the joint hypotheses of our pricing model and the hypothesis that capital markets for large firms are integrated with the markets for small firms.