Abstract
In this chapter, we take the practical approach to measure equity market correlations and propose the use of trends gaps to assess diversification benefit in global equity markets. We suggest that one should consider the prevalence of market trends to gauge the state of global stock market correlations. This is important in assessing the benefits of international diversification. The idea of our approach is that the states indicated by the prevalence can be used when assessing the benefits of international diversification. The chapter relates upward and downward trends to bull and bear markets and re-estimates correlations between developed and emerging markets. Interestingly, we find that market trends are more prevalent in emerging markets. The results also suggest that, from the perspective of the relative prevalence of bull markets versus bear markets, the emerging stock markets have provided advantages for investors because of relative prevalence of their bull market trends. The correlation analysis on trend gaps implies that the extreme trend gaps, not just extreme market movements, are also related to higher correlations between different markets. One may find the highest correlations between different markets when their market trends do not collide. Furthermore, we suggest that the prevalence of market trends could be used as an indicator to gauge the state of the global stock market.
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