Portfolio diversification between developed and developing stock markets: The case of US and UK investors in Nigeria

Abstract

This study investigates the availability of potential portfolio diversification benefits for US and UK investors diversifying equity portfolio with Nigerian stocks. It employs VAR-BEKK-GARCH model and utilizes conditional variance and covariance from the model to estimate optimal portfolio weight (OPW) and optimal hedging ratio (OHR) to examine optimal portfolio management options in case of financial risk from developed stock markets. Its main contributions are: (i) it examines the case of Nigeria, which is one of the countries attracting the largest share of foreign investment in Africa (ii) it identifies and accounts for structural break in empirical model for international portfolio diversification; omission of which could cause biasness of result. Evidence from this study shows that there are potential gains for US and UK investors diversifying equity portfolio with Nigerian stocks, and there are potential effects for financial risk or financial bubble to transmit from US and UK stock markets to Nigerian stock market. Further evidence from OPW and OHR results show that US (UK) investor could minimize the effect of financial shocks from US (UK) stock market on his Nigeria – US (UK) equity portfolio by holding about 10% (25%), and taking short position of about 9.4 cent (16.6 pence), in Nigerian stocks.