Abstract
We use mean-variance analysis with short selling constraints to diagnose the effects of the recent global financial crisis by evaluating the potential benefits of international diversification in the search for ‘safe havens’. We use stock index data for a sample of developed, advanced-emerging and emerging countries. ‘Text-book’ results are obtained for the pre-crisis analysis with the optimal portfolio for any risk-averse investor being obtained as the tangency portfolio of the All-Country portfolio frontier. During the crisis there is a disjunction between bank lending and stock markets revealed by negative average returns and an absence of any empirical Capital Market Line. Israel and Colombia emerge as the safest havens for any investor during the crisis. For Israel this may reflect the protection afforded by special trade links and diaspora support, while for Colombia we speculate that this reveals the impact on world financial markets of the demand for cocaine.
Highlights
The potential benefits arising from international portfolio diversification are well documented in the financial literature
The gains from international portfolio diversification in the pre-crisis period are displayed in Figure 1 and Table 3
In this paper we examine the possibility that particular countries could emerge as ‘safe havens’ for international investors during a period of crisis, looking at the recent global financial crisis in particular
Summary
The potential benefits arising from international portfolio diversification are well documented in the financial literature. An issue of fundamental importance to investors everywhere, and so at times of global crisis, is how diversification may include investment in ‘safe havens’. Times of crisis have induced flight into gold in particular and precious commodities in general but there may be potential for investment in particular economies (countries). At times of crisis both the international co-movement between stock markets and the prices of safe haven assets may increase rapidly, potentially making any ‘flight to safety’ either expensive or ineffective. The contribution of this paper is to add to the debate on international diversification by using mean-variance analysis in a novel way to identify countries whose stock markets provided potential safe havens during the recent global financial crisis. The results are somewhat unexpected and potentially raise policy issues of considerable importance – Colombia emerges as the ‘safest haven’ by a very wide margin among the countries sampled, followed at some distance by Israel
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