What factors explain stock returns in Latin America? An analysis of the period 1995-2000

We explore the evolution of Latin American stock returns and potential factors affecting them in the second half of the 90s. The evidence suggests that stock returns exhibited high volatility, were non-normally distributed, and became increasingly correlated across the region. The high correlations suggest that there was a regional or international factor that led to comove-ments of stock returns in the region. This is consistent with our finding that returns in each market can not be understood by means of traditional multi-factor models that use firms ’ attributes as main explanatory variables. The relevance of the international factor is supported by previous evidence showing that stock return comovements were associated with the evolution of international equity flows. Comovements can not be directly explained by herding behavior, but by the fact that investors treat emerging markets as a separate asset class in global portfolio management. Herding behavior amplifies flow reversals, which in turn lead to drastic comovements, specially in periods of extreme risk aversion