Are Financial Assets Priced Locally or Globally? G.Andrew Karolyi and Rene M.Stulz NBER Working Paper No.8994 June 2002 JEL No.G11,G12,G15 ABSTRACT We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices.International asset pricing models with mean-variance investors predict that an asset's risk premium depends on its covariance with the world market portfolio and, possibly,with exchange rate changes.The existing empirical evidence shows that a country's risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns.However,the theoretical asset pricing literature relying on mean-variance optimizing investors fails in explaining the portfolio holdings of investors,equity flows, and the time-varying properties of correlations across countries.The home bias has the effect of increasing local influences on asset prices,while equity flows and cross-country correlations increase global influences on asset prices. G.Andrew Karolyi Rene M.Stulz Fisher College of Business Fisher College of Business Ohio State University Ohio State University 2100 Neil Avenue 2100 Neil Avenue Columbus,OH 43210-1144 Columbus,OH 43210-1144 and NBER stulz 1@cob.osu.eduAre Financial Assets Priced Locally or Globally? G. Andrew Karolyi and René M. Stulz NBER Working Paper No. 8994 June 2002 JEL No. G11, G12, G15 ABSTRACT We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices. International asset pricing models with mean-variance investors predict that an asset’s risk premium depends on its covariance with the world market portfolio and, possibly, with exchange rate changes. The existing empirical evidence shows that a country’s risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns. However, the theoretical asset pricing literature relying on mean-variance optimizing investors fails in explaining the portfolio holdings of investors, equity flows, and the time-varying properties of correlations across countries. The home bias has the effect of increasing local influences on asset prices, while equity flows and cross-country correlations increase global influences on asset prices. G. Andrew Karolyi René M. Stulz Fisher College of Business Fisher College of Business Ohio State University Ohio State University 2100 Neil Avenue 2100 Neil Avenue Columbus, OH 43210-1144 Columbus, OH 43210-1144 and NBER stulz_1@cob.osu.edu