Abstract
The purpose of this study is to assess the diversification benefits resulting from international asset allocation. In this study, we examine Capital Asset Pricing Model (CAPM) in its international ontext (ICAPM) using the monthly equity returns for 26 countries (18 developed and 8 emerging markets) between July 1996 and June 2011 and adopting the US investor’s perspective. We verify the beta-return trade-off employing two approaches: the unconditional trade-off and the conditional relationship. In this latter case, we find the country beta to be a significant variable explaining the cross-country variation of returns. Next, we test the degree of market integration in the light of the ICAPM. The results of this test indicate that country-idiosyncratic risks are generally not priced. In the subsidiary outcomes of our verification procedure, we argue that country betas are time-varying and that currently, global factors are the dominant source of equity market volatility. Consequently, the opinion regarding emerging market assets and their role in global portfolio management should be reconsidered. The results of the entire study may provide essential implications for fund managers because the decreasing international diversification gains have been identified.
Highlights
The position of the Capital Asset Pricing Model (CAPM) in finance is unique for several reasons.CAPM is a mandatory topic in every academic course on financial markets
The position of the CAPM in finance is unique for several reasons
It is crucially important to understand that idiosyncratic risk can be eliminated by holding a diversified portfolio
Summary
CAPM is a mandatory topic in every academic course on financial markets. The general conclusion of CAPM implies that the expected return for any security is positively related to the risk carried by this asset. This relationship is represented by the following equation: E(Ri ) = R f + βi [E(Rm ) − R f )] , (1) Vizja Press&IT. Radosław Kurach nies and that leads to broader market volatility. It is crucially important to understand that idiosyncratic risk can be eliminated by holding a diversified portfolio. In the CAPM world, the expected return on any security is related only to the portion of the total risk that is generated by the common risk factor. Rational and risk-averse investors should a hold diversified portfolio with no idiosyncratic risk, so the unsystematic component should not be priced
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