The positive but low correlations between commodity prices and emerging market stock returns can be explained by a number of factors, including the relative importance of supply, demand, currency fluctuations, and other factors that may influence commodity prices at any given time (Davis and Aliaga-Diaz, 2008). Over the past several years, for instance, the correlations between emerging markets and commodity prices have been higher than those indicated in Figure 13 because of changes in the commodity demands of the BRIC economies.

Overall, Figure 13 is a reminder that stock returns on a broad emerging market index are not driven solely by changes in commodity prices. Moreover, the relationship between commodity prices and stock prices varies significantly across individual emerging markets, depending on their own commodity intensity and relative terms of trade (the ratio of commodity export prices to import prices). The monthly returns on the MSCI Chile Stock Index, for instance, are highly correlated with copper prices (Chile is a prominent exporter of copper), yet are virtually uncorrelated with oil prices (Chile is a net importer of oil).

Conclusions

The financial crisis that first erupted in the U.S. subprime mortgage market in August 2007 has evolved into the largest financial shock since the Great Depression, inflicting heavy damage on markets and institutions around the world. Indicative of the magnitude of the shock, equity market volatility is at or near unprecedented levels, corporate bond yields are extremely high relative to U.S. Treasury yields, and commodity prices have plummeted. With the global financial system deleveraging and the U.S. economy in the midst of a severe recession, the global economy is decelerating quickly after years of heady growth.

These profound recent developments raise important longer-term questions with respect to the world economy and global financial markets. In this paper, we find that-despite more integrated trade and financial linkages around the world-the global business cycle accounts for only approxi­mately 50%-60% of the volatility in real GDP growth across the major developed and emerging market economies. The remaining economic volatility is a result of region-specific and country-specific factors. Of course, the correlation among international business cycles varies over time, by country, and by the source and magnitude of financial shocks. Broadly speaking, cross-country correlations in real GDP growth rise whenever (1) asset-price shocks are systemic (e.g., the 1970s oil-price shock) and (2) the world's largest economies are severely impaired in the process (e.g., the situation in the United States today).

We further show that the U.S. economy remains the primary accelerator of world economic growth, even though the BRIC economies have clearly emerged as an important factor. As a result, emerging market economies remain fully coupled to severe U.S. recessions and global financial crises. In more normal conditions, the economic correlations between emerging markets and developed markets tend to be lower than the business-cycle correlations among industrialized countries.

Finally, we document the well-recognized pattern that short-run correlations among international equity markets tend to be asymmetric: correlations rise dramatically during global financial crises. However, this stylized fact does not invalidate the benefits of global equity diversification. Indeed, the diversification benefits of international investing are most apparent after financial crises subside, given the heterogeneous economic structures, capital-flow sensitivities, commodity-price exposures, and varied monetary and fiscal policy responses of countries around the world.

Appendix

We collected annual data on real per-capita GDP regions based on real GDP weights. Figure 14 growth over the sample period 1951-2007 for the provides a complete list of the countries and 49 countries currently in the MSCI World Equity regional classifications and the first year for which Index. We calculated real GDP growth rates for data were available for each country. developed markets, emerging markets, and various regions based on real GDP weights. Figure 14 provides a complete list of the countries and regional classifications and the first year for which data were available for each country.

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