Abstract
We estimate the long-run relationships among NAFTA capital market returns and then calculate the weights of a ?time-varying minimum variance portfolio? that includes the Canadian, Mexican, and USA capital markets between March 2007 and March 2009, a period of intense turbulence in international markets. Our results suggest that the behavior of NAFTA market investors is not consistent with that of a theoretical ?risk-averse? agent during periods of high uncertainty and may be either considered as irrational or attributed to a possible ?home country bias?. This finding represents valuable information for portfolio managers and contributes to a better understanding of the nature of the markets in which they invest. It also has practical implications in the design of international portfolio investment policies.
Highlights
During the 1970s and 1980s, many empirical studies focused on the determination of the optimal parameters that portfolios of risky assets should have in the theoretical context of the mean-variance model, increasingly incorporating the effects of international diversification and reporting encouraging results
To obtain a more precise understanding of that phenomenon, some authors have proposed the use of Autoregressive conditional heteroskedasticity (ARCH) models; others have suggested the use of Generalized autoregressive conditional heteroskedasticity (GARCH), and still others different variations of ARCH (Tim Bollerslev 2008)
In the face of extreme market turbulence, the adequate investment strategy for a risk-averse investor in a NAFTA market is to constantly rebalance the minimum general risk portfolio (MGRP) in order to respond to changing domestic market return variances and cross-country covariances
Summary
During the last two decades, there was an interest in studying the gradual reduction in diversification benefits across different national capital markets due to increasing integration and globalization of financial markets. The results obtained from their estimates over 38 years of monthly observations (January 1959 to December 1996) of the five largest stock markets (USA, UK, France, Germany, and Japan) rejected that hypothesis, at least for negative returns They reported that the correlation of highly negative returns does not converge to zero but tends to increase with the limit used, with high statistical significance. Jesús Cuauhtémoc Téllez Gaytán and Pablo López Sarabia (2010) used different frequency observations to analyze the correlation between the Mexican stock exchange index and other Latin American stock market indices and key market indicators for the USA stock markets Their results, based on a wavelet analysis, indicated that the correlation between the Mexican stock market and the other markets was not very intense, and only in a few cases did the correlations exceed 0.7, which calls into question whether the co-movement is as intense as that reported by other studies. It should be noted that the correlation levels estimated by Téllez Gaytán and Sarabia for the stock markets of Mexico and the USA seem reasonable (compared with the results reported by López-Herrera, Ortiz, and Cabello 2009), these may attain higher levels during periods in which there are extraordinary market pressures (cracks or financial panics)
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