Global Diversification Benefits: Empirical Evidence from Frontier Emerging Markets

Abstract

We document the case of global diversification benefits, that can be achieved by the new emerging markets in the world. The so-called frontier emerging markets, along with 4 emerging markets namely Brazil, Russia, India and China and 3 developed markets USA, UK and Japan. We are the first to use a common subset of frontier emerging markets from three distinct index providers, MSCI, S&P and Russell, and thereby covering more than 80% of the respective index constituents.This study explores the dynamic relationship between the degree of financial market integration for developed and emerging markets with that of frontier markets. We use daily stock index data for the given markets, and use different statistical methods for modeling linear and non-linear serial dependence using GARCH, GJR-GRACH, E-GARCH and DCC models. Further our results highlight the presence of significant time-varying conditional correlations between these markets. During crisis periods or turbulence dynamic correlation falls, for frontier markets compared to emerging markets. Our results indicate that investors who expand their investment opportunity set by gaining exposure to frontier markets can significantly improve the efficiency of their investment portfolio on a risk-return metric, even after controlling for transaction costs.