Long-Term Global Market Correlations

Transcription

1 Log-Term Global Market Correlatios Global Likages Pre-oferece IMF, April, William N. Goetzma, Ligfeg Li K. Geert Rouwehorst

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3 Hery Lowefeld, It is sigificat to see how etirely all the rest of the Geographically Distributed stocks differ i their price movemets from the British stock. It is this idividuality of movemet o the part of each security, icluded i a well-distributed Ivestmet List, which esures the first great essetial of successful ivestmet, amely, Capital Stability. From: Ivestmet ad Exact Sciece,.

4 History of Diversificatio! First Mutual Fud: Eedracht Maakt Magt ()! Daish ad Vieese baks! Daish Tolls ad Holstei! Russia ad Swede! Bruswick ad Meckleburg! Postal services of Saxoy! Spaish Caals of Taouste ad Imperial! British Coloies! Essequebo! Berbice! Daish America Islads

5 Diversificatio: First Mutual Fuds! I the portfolio costructio the fud will observe as much as possible a equal proportioality! Because othig is completely certai, but subject to fluctuatios, it is dagerous to allocate all capital to a sigle security! Nobody will have reaso to believe that all securities will stop payig off at the same time thereby losig the etire ivested capital

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7 Determiats of Diversificatio! Correlatio betwee the assets i the portfolio " Take a log-term look at market correlatios over time! The umber of assets i the portfolio " Markets have disappeared ad (re-)emerged over time! What is the relative cotributio of chagig correlatios ad evolutio i the ivestmet opportuity set for diversificatio beefits?

8 Preview of Results! Major shifts i correlatios through time.! Correlatios are lower durig periods of capital market segmetatio tha durig itegratio.! Beefits of diversificatio amog core markets are curretly lower tha i the s.! Decompositio shows that curretly about half the beefits come from opportuity set growth ad half from correlatio structure of markets.! Recet globalizatio has ot dimiished the diversificatio beefits for the average ivestor

9 Data! Mothly equity market idex returs for about coutries, coverted to USD.! Sources: Jorio ad Goetzma (), Global Fiacial Database, Ibbotso Associates, IFC.! Simulate perspective of the U.S. based global ivestor.

10 Data Issues! Missig coutries, missig data " Little data before " Russia i th cetury, Chia, Japa " Divided iformatio ofte uavailable! Which markets were ivestable ad whe? " Portfolios assume that foreig markets ivestable! Trasactios costs?! Prices accurately recorded?! Cap-weighted vs. equal-weighted?

11 Foudig Dates For World Equity Markets Netherlads Frace Belgium Austria UK USA Irelad Italy Demark Polad Russia Switzerlad Spai Peru Cuba Swede Hugary Turkey Czech Australia New Zealad Argetia Caada Brazil Japa () Norway Egypt () South Africa Sigapore Hog Kog Greece () Chile Veezuela Mexico Yugoslavia states Zimbabwe Sri Laka Portugal Chia Korea Idoesia Filad Lebao Sloveia Uruguay Philippies Morocco Roumaia Luxembourg Colombia Malaysia Pakista Israel Keya Taiwa Nigeria Kuwait Ira Tuisia Thailad Jamaica Jorda Triidad-Tobago Icelad Bahrai Mauritius Botswaa Ghaa Swazilad Chia Slovak Namibia Egypt Zambia Malawi Malta Tazaia

12 Year Argetia # "Log period of declie" Australia # # Austria # Belgium # V -XII Brazil # Predomoatly Bods Caada # # Chile #?? Chia # Columbia Czechoslovakia # Demark # IX-X Egypt Filad # # Frace? Germay Late th Cetury /IV/ Greece # Hog Kog # Hugary # Idia # # Idoesia Irelad # Israel Italy # Jamaica Japa # Jorda Keya Korea Kuwait Lebao Luxembourg Malaysia Mexico # Netherlads # V -IX VIII VI New Zealad # Nigeria Norway # # # Pakista # # Philippies Polad # Portugal # Roumaia? Sigapore # South Africa # Spai # SriLaka Swede # Switzerlad # Taiwa Thailad Triidad Turkey # UK # # Uruguay USA # Veezuela # # # Yugoslavia # goslavia (Sloveia

13 Sample Market Etry ad Exit Number of Coutries Core Markets Total Available Markets

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15 Basu -Taylor () Episodes! -: Early Itegratio! -: Tur of the Cetury! -: World War I! -: Betwee the Wars! -: World War II! -: Bretto Woods! -: Preset

16 Pairwise Correlatios Core Coutries.. Correlatio.. UK-US UK-F UK-G US-F US-G F-G

17 Average Correlatio US UK Germay Frace segmetatio itegratio full - Correlatio

18 Decomposig diversificatio beefits! Beefits of diversificatio exteds far beyod core markets! Recet era shows high average correlatio amog core markets, but there are curretly may more markets available for diversificatio.! Does icrease i opportuity set compesate for icrease i average correlatio?

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20 Diversificatio measure - ( ) ( ) ( ) ( ) ( ), / = = = = = + = i i j i j i i i i i i i i i x Var x x Cov x Var x Var x Var x Var ( ) ( ), i j i x Var x x Cov + =

21 Diversificatio measure -! Diversificatio beefits measured by the ratio of : " retur variace of a diversified portfolio " average retur variace of the assets i the portfolio! Ratio lies betwee ad : " : perfect correlatios " : ucorrelated returs

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23 Decomposig the Beefits of Iteratioal Diversificatio equally-weighted portfolio variace / average market variace. Ratio portfolio volatility / average market volatility.... Core Coutries (limited diversificatio) Average four coutries All Coutries (ulimited diversificatio).

24 Curret diversificatio beefits -! Variace of a portfolio of core markets is curretly about % of the average idividual coutry variace (% reductio)! Core markets have higher correlatio tha emergig markets: average portfolio of markets provides % risk reductio! Maximum global diversificatio offers % risk reductio! Expasio of opportuity set cotributes about half of the total diversificatio beefits

25 Curret diversificatio beefits -! Effect of icrease i the ivestmet opportuity set has bee twofold: " Emergig markets have lower correlatio tha developed markets: risk reductio rises from % to % " The icrease i the umber of markets: risk reductio rises from % to %! Expasio of opportuity set doubles diversificatio beefits (from to %): about half comes from lower correlatios have from icrease i the umber of markets

26 Equilibrium diversificatio beefits -! Not every ivestor ca hold a equally-weighted portfolio! Assets have to be held i proportio to market weights! Weight of smaller/emergig markets eeds to be reduced! What do equilibrium beefits of diversificatio look like?

27 Recet Beefits of Iteratioal Diversificatio value-weighted portfolio variace / market variace Ratio portfolio volatility / average market volatility.... Core Coutries (limited diversificatio) All Coutries (ulimited diversificatio)

28 Equilibrium diversificatio beefits -! Beefits are geerally lower because value-weighted portfolios are less diversified.! Despite the slow rise i retur correlatios, the beefits to iteratioal diversificatio have bee remarkably stable over last years! Emergig markets double the beefits to diversificatio across core markets.

29 Coclusios! Loger view reveals shifts i correlatios.! Itegratio is associated with high market correlatio! While correlatios are at highpoit i history, ivestors beefit from a expasio of the ivestmet opportuity set! About half of curret beefits stem from expasio of opportuity set.! Diversificatio beefits have bee remarkably stable for average ivestor over last years.