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Suppose I pick an index of the American stock market -- the S&P 500, and an index of the Japanese market -- the Nikkei 225. Suppose for a moment that I expect the amount of risk in each index to be roughly the same.

Should I expect equal returns from both indices?

On one hand, I might think "no", since stagnating population and demographic issues in Japan have been reflected in the fact that Nikkei 225 index is lower now than it was 30 years ago.

On the other hand, I might also be tempted to think "yes", because if it was really true that we can't expect steady economic growth from Japan anymore, but we can from America, then people holding japanese stock should've sold them in exchange for american stock, depressing the price until the expected returns were equal again. If the expected growth rate were lower than the risk free rate, then the price should drop to 0. In other words if the EMH prevents me from beating the market, it should also prevent me from losing to it.

Which of these lines of thought is correct?

  • There are some obstacles in the way of international trading, in addition to nationalistic pride, that will support some hysteresis in the equilibrium between markets. – Ben Voigt Apr 21 at 19:39
  • @BenVoigt thanks for the reply -- are these obstacles really great enough to deter institutional investors from buying and selling what they want? I agree there can't be perfect equilibrium between markets, but shouldn't it be at least pretty close? – shimao Apr 21 at 19:50
  • "then people holding japanese stock should've sold them in exchange for american stock" The same logic can be applied iteratively to national stock, sectors of economy, individual businesses. Eventually everyone would end up with stock of the same single company. Strive for diversification opposes that. – void_ptr Apr 22 at 17:16
  • @void_ptr: No, everyone would not end up invested in the same solitary company. Supply-and-demand provides negative feedback, increasing the price of that company which decreases the return (as a proportion of investment). As the OP already pointed out in the question. – Ben Voigt Apr 22 at 21:12
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No. Each economy is different in terms of interest rates, rates of inflation, and rates of national economic growth. All of those are factors in the rate of return of a country's equity market, so their rates of return will be different.

I would also note that even different indices within a country's market will be different. The return of the S&P 500 (a large-cap index) is different than, say, the Russell 2000, which in an index of small-cap companies with higher risk and (on average) higher expected return.

  • Don't forget military strength as well as security council seat and past imperialist holdings. – paulj Apr 23 at 17:34

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