Higher correlation of US equity market with international equity markets

EOC solution says it will increase the US equity risk premium. Is this because of less diversification effect?


i thought from the perspective of domestic invstor … if Int equity market has high correlation, then the internaional equity would have increased risk premim (due to lack of diversification benefit).

Not 100% sure why the US equity risk premium would increase. Only thing i can think of - if there is a crisis in int market, then US equity is also impacted (as they’re correlated … and don’t have diversification benefit) … so i guess it impacts both sides - so both will have increased risk premium.

Think of the ICAPM, Beta has a correlation component.

Higher Beta, higher Equity Risk premium

Thank you!

Frank, when highly correlated, the integrated component of the risk prem increases due to correlation which causes overall equity risk prem to increase. This should not effect segmented component iMo

Thanks ov25, EOC R17 Q12.

Not sure it’s implied it will affect segmented componenet?

Higher integration results in higher ERP, because of higher correlation coefficient.

BUT: full segmentation results in higher ERP than integration, because of correlation coefficient of 1.