Dual role of the country factors in international asset pricing: The local factors and proxies for the global factors

Abstract

Considering that the popular Fama–French–Carhart (FFC) factors are actually long–short stock portfolios, we (i) test if the FFC six country factors are globalized, (ii) compare the pricing performance of the global, country, and local (orthogonalized) factors, and (iii) examine the pricing implications of the globalized country factors. We find: Most country factors are significantly globalized as measured by R2 from regressing the country factors on the global factors. The R2, however, varies greatly across countries and factor types, ranging from 0.03 for the Hong Kong value factor to 0.88 for the U.S. market factor during 1990–2017. In terms of asset pricing, the country factors perform the best and the local factors the worst. The well-known outperformance of the country factors over the global factors in pricing arises from the “dual role” the country factors play in partially integrated markets, i.e., the country-specific local factors and proxies for the global factors.