International Equity Investment Research Articles

The plausibility of risk estimates and implied costs to international equity investments

Abstract We reconsider the costs to international equity investments implied by standard portfolio theory (Cooper and Kaplanis, 1994; Sercu and Vanpee, 2008). Estimated costs are mostly driven by risk estimates, not by asset holdings. For OECD markets, risks are fairly stable and relatively easy to estimate, but for emerging markets this is not the case. Many required expected returns implied by unconditional risk estimates defy credibility, both a priori and empirically. More sophisticated volatility estimates based on a dynamic risk model a la Bekaert and Harvey (1997) lead to implicit costs that are far more credible, but the results remain fragile.

The Home Bias in Equities and Distribution Costs

We show that including distribution costs into a general equilibrium model of inter- national portfolio choice contributes to explaining the home bias in international equity investment. Our model is able to replicate observed investment positions for a wide range of parameter values, even if agents have an incentive to hedge labor income risk by purchasing foreign equity. This is because the existence of a retail sector affects both the correlation of domestic returns with the domestic price level and the correlation between financial and nonfinancial income.

Domestic and Foreign Country Bias in International Equity Portfolios

I provide an analysis of the home bias in international equity investments using data for the year-end 2006. Distinguishing two components of the local equity preference – the “domestic country bias” indicating whether local investors overinvest the domestic market, and the “foreign country bias” indicating whether investors overinvest or underinvest a particular destination – I find that emerging countries’ investors hold systematically larger shares in their local markets compared to their counterparts in developed countries. Disaggregation of the cross-border assets by destinations reveals mixed patterns as captured by the country bias ratios. While investors generally allocate trivial portions to some foreign markets and completely disregard others, I uncover several positive country bias ratios suggesting that the destination market is overweighted by the source market’s investors. Geographical proximity is central to characterize such bilateral holdings. Finally, investors prefer to invest mostly in developed countries with larger equity markets so that the amounts held in only a handful of destinations suffice to account for a big part of the existing foreign equity. I refer to this observation as the “geographical shrinkage” in portfolio investments along the well-documented home bias puzzle.

The impacts of country risk and cultural distance on transnational equity investments

PurposeThe purpose of this paper is to clarify the influence of country risk (CR) and cultural distance (CD) on transnational equity investments. It also tries to find out the international equity investment patterns of enterprises from developing countries like China.Design/methodology/approachFrom the perspectives of internalization theory, transaction cost theory, etc. this paper tries to explain the relationships between country‐level factors and transnational investment. Based on the data collected from overseas listed companies, it also empirically analyses the impacts of CR and CD on Chinese enterprises' ownership pattern in transnational equity investment.FindingsThe empirical results of this paper indicate that both the risk of host country and CD between host country and home country have significant and negative impacts on the level of ownership equity, but insignificant impacts on ownership status.Research limitations/implicationsAs there are still some doubts about the existence of country culture, especially when dealing with a huge country like China, the use of Hofstede's instrument may be one of the limitations of this paper. Also, by focusing on Chinese enterprises, the research results may lack generalisability. Therefore, researchers are encouraged to test the proposed propositions when they study enterprises from other developing countries.Practical implicationsThe paper sheds light on international investment activities of Chinese enterprises, and also provides insights for the decision making on equity arrangement in transnational investment.Originality/valueThis paper is one of the first to analyse the international equity investment activities of Chinese enterprises and it provides new evidence on how the country‐level factors influence transnational equity investment decisions.

The Plausibility of Risk Estimates and Implied Costs to International Equity Investment

In this paper we reconsider the estimated deadweight costs for the emerging countries implied by the mean-variance portfolio model developed by Cooper and Kaplanis (1994) and generalized by Sercu and Vanpee (2007). We show both theoretically and empirically that estimated implicit investment costs are mostly driven by estimated risk if home bias is strong, which is particularly the case for emerging markets. For OECD countries, riskis stable and relatively easy to estimate, but for emerging markets ex post risk may be very different from ex ante risk and changes substantially over time. The required expected returns that go with the naive risk estimates and are at the basis of the high implied costs of international equity investments defy credibility, whether a priori or empirically. We show that more sophisticated volatility estimates based on a time-varying model ala Bekaert and Harvey (1997) lead to implicit investment costs that are far more credible.

Institutional Determinants of International Equity Portfolios - A Country-Level Analysis

Despite large potential gains, international equity investment is less diversified across countries than predicted by the international version of the traditional capital asset pricing model (ICAPM). This paper provides empirical evidence on the impact of capital market frictions on international equity portfolios using data on bilateral equity holdings. Two important findings are reported: First, besides a home bias in equities, a 'friendship bias' can be observed for some country pairs. Second, indirect barriers such as the degree of financial market development and especially information asymmetries have strong explanatory power, whereas direct barriers such as capital flow restrictions have no impact on the portfolio share of foreign equities.

Estimating the Costs of International Equity Investments

We generalize the Cooper and Kaplanis (1994) methodology for estimating the costs that could reconcile international portfolio holdings with CAPM predictions. First, we can simultaneously estimate inward and outward investment costs and even interactions between home and host country. Second, the risk aversion parameter is estimated rather than postulated. Third, we control for exchange rate risk, inflation hedging, fixed-interest investments, round-tripping and omitted countries. Our estimates of implicit investment costs for the developed countries are much lower than those reported in prior studies. Over the period 2001-2004, our estimates of the average inward shadow costs range from 0.01 (US) to 37 (Indonesia) percent per annum. We find that the equity home bias is related to a mixture of market frictions, such as information asymmetries, institutional factors and explicit costs.

Estimating the Costs of International Equity Investments

Estimating the Costs of International Equity Investments

Institutional Determinants of International Equity Portfolios - A Country-Level Analysis

Despite large potential gains international equity investment is less diversified across countries than predicted by the international version of the classical capital asset pricing model (ICAPM). This paper provides empirical evidence on the impact of capital market frictions on international equity portfolios using data on bilateral equity holdings. Three important findings are reported: First, the home bias in equities puzzle does not exist for all observed country pairs, instead a 'friendship bias' can be observed. Second, indirect barriers such as the degree of financial market development and especially information asymmetries have strong explanatory power, whereas direct barriers such as taxes and capital controls have almost no impact on the portfolio share of foreign equities. Third, diversification motives have an impact on the relevance of capital market frictions.

Investing in Global Equities

Accelerating globalization of business enterprise and the integration of capital markets are altering the international equity investment environment. The empirical evidence suggests that security price returns have become more closely associated with industry affiliation than with country of domicile. Within-country comparisons of securities are now a less effective way to identify attractively valued stocks; comparing securities within global industries and across countries appears instead to provide a more powerful approach to identifying future winners. Structural changes like these necessitate a more global approach to equity investing. Plan sponsors, asset managers, and individual investors should respond by altering their investment process to reflect this new economic reality.

The Importance of Banking in Gulf Cooperating Economies

Gulf Cooperating Countries (GCC) are in the process of strengthening and expanding financial markets in relation to listing, regulatory, trading and settlement procedures. Along with the opening up of markets to international investment, innovations that should enhance overseas investor interest include the development of meaningful GCC share returns and banking share returns indices. It is clear from almost four years of daily data, that unlagged GCC banking returns and GCC stock market returns are significantly and positively related. Over the longer term, they are also significantly cointegrated. The GCC banking industry is a major component of the GCC share market. Causality tests demonstrate that dual causality exists but stronger causality runs positively from GCC banking returns to GCC stock market returns. GCC banking stock returns are exogenous. The evidence supports the notion that, because of such interdependence it is vital for the economic health of the GCC, that their banking systems remain financially sound. However in order to relieve the mounting pressure on bank debt as oil revenues and repatriated funds dwindle, it is important that the stock markets be opened in due course to outside or non Arab international equity investment.

A New Framework for International Investing

Three interrelated issues in international investing are explored here. First, despite (or because of) years of underperformance, international equity investment strategies are very much worth pursuing. Second, high levels of active risk are not necessarily a winning strategy in international equities; an aversion to active risk is just as rational in international markets as it is domestically. Finally, when investment decisions that are naturally separate are in fact separated, the efficient frontier moves up and to the left?portfolio efficiency improves?because we use more of the information collected by the analyst. Thus, in international portfolios, the investment manager should make security, country, and currency decisions independently of one another, and arguably admit short as well as long positions.

Privatization and the Rise of Global Capital Markets

This study has two objectives: to estimate the impact of share issue privatisations on the growth of world capital markets (especially stock markets), and to examine the effect privatisation has had on the pattern of share ownership by individuals and institutional investors. We begin by documenting the increasing importance of capital markets, and the declining role of commercial banks, in corporate financial systems around the world. We then show that privatisation programmes have had a dramatic impact both on the development of non-U.S. stock markets and on the participation of individual and institutional investors in those markets. Our research documents the following key points: (1) the fraction of total domestic credit provided by the banking sector, as a percent of GDP, remained virtually constant (125 percent) between 1990 and 1998 for the world as a whole, as well as for most major country groupings. (2) During that same time period, stock market capitalisation as a percent of GDP increased from 52 to 82 percent for the world as a whole, and from 56 to 95 percent for high income countries. Market capitalisation is now over $39 trillion, which almost certainly exceeds world capitalisation. (3) Share trading volume (value of shares traded) increased even more dramatically, from 29.0 percent of world GDP in 1980 to 79.3 percent in 1998, when it reached $22.9 trillion. (4) The total market value of privatised firms grew from less than $50 billion in 1983 to almost $2.5 trillion in 1999-roughly 10 percent of the world's aggregate market capitalisation, and 21 percent of the non-U.S. total. (5) Privatised firms are the most valuable companies in seven of the ten largest non-U.S. stock markets, including the four largest, as well as in most developing countries. (6) Share issue privatisations (SIPs) have transformed international equity issuance and investment banking practices. The 25 largest - and 35 of the 39 largest - common stock issues in history have all been privatisations, and governments have raised over $700 billion through some 750 SIPs since 1977 - and over $1 trillion through all privatisation methods. (7) Academic research has now clearly established that, in most countries, SIP investors earn significantly positive excess (market-adjusted) returns on the shares they purchase - over both short and long term holding periods. (6) Privatisations have dramatically increased the number of shareholders in many countries. Almost two-thirds of the 54 non-U.S. firms (67 including US companies) with over 500,000 shareholders are privatised companies, and roughly a dozen SIPs have more than 1,000,000 initial shareholders. SIPs generally have a far larger number of stockholders than do capitalisation-matched private firms in the same country. (7) However, we also find that the extremely large numbers of shareholders created by many SIPs are not a stable ownership structure. For the 47 offers that initially yield over 250,000 shareholders, the total number of shareholders declines by one-third within five years.

CURRENCY-TRANSLATED FOREIGN EQUITY OPTIONS WITH PATH DEPENDENT FEATURES AND THEIR MULTI-ASSET EXTENSIONS

Currency-translated foreign equity options (quanto options) are designed for investors who would like to manage different types of risk in international equity investments. The terminal payoffs of quanto options depend on the price of a foreign currency denominated asset (or stock index) and the exchange rate in different combinations of choices. This paper presents a systematic framework to derive pricing formulas for different European-style quanto options with path-dependent payoff functions. The path dependent features can be the barrier feature associated with the underlying asset price movement, the averaging feature of the exchange rate over the life of the option, etc. In many cases, the pricing formulas for quanto options can be inferred from their vanilla counterparts by applying the quanto-prewashing technique of making modifications on the risk neutralized drift rates and volatility rates. The extension of the pricing formulations to multi-asset extremum options with the quanto feature is also considered. The pricing behaviors of the joint quanto options and the Asian quanto options are examined.

International Stock Market Equilibrium with Heterogenous Tastes

This paper considers a dynamic real exchange model of international trade in commodities and equities. Given “generalized Cobb-Douglas” intraperiod tastes that differ across countries, we find a closed-form solution with properties that are noteworthy, not because they reverse our presumptions, but because they exceed them. A consumption-based model of international equity investment might be expected to have the following properties: (i) The optimal portfolios should reflect the international pattern of commodity expenditure. (ii) A country’s portfolio should be biased toward equities in commodities that attract a large share of its expenditure. (iii) A country would short some equities, given an appropriate structure of equity returns. (iv) Short sales of equities would allow the international economy to move toward the situation that would prevail if risk markets were complete. In our model solution, these properties take strong forms:

International equity investment with selective hedging strategies

In this study, we examine the construction of ex ante internationally diversified stock portfolios under both parameter uncertainty and exchange rate uncertainty. Both passive and active strategies are explored for handling exchange rate uncertainty. One passive strategy is to always use forward contracts to hedge exchange rate risk. A second is to use protective puts to hedge the exposure. Three conditional hedging strategies based on the random walk model are also explored. The random walk strategy exhibited superior performance in comparison with the unhedged and passive hedging strategies under all parameter estimation techniques. These results imply that the random walk model provides a good estimate of next period's spot rate of exchange.

A multinational examination of international equity and bond investment with currency hedging

A multinational examination of international equity and bond investment with currency hedging

An Information Based Explanation of the Domestic Bias in International Equity Investment

The domestic bias in international equity investment presents a major challenge to asset pricing models building on the assumption of symmetrically informed investors. Some further evidence on the home bias is provided and the question of why foreign exchange risk or capital controls are not sufficient to explain the full effect is discussed. A simple noisy rational expectations model is introduced where, even in equilibrium, investors remain incompletely informed. It is shown that the domestic bias arises quite naturally when investors are on average better informed about domestic stocks.

Benefits from diversification and currency hedging of international equity investments: different countries' viewpoints

The benefits from international portfolio diversification have been widely researched but mostly from a U.S. investor's viewpoint. This paper investigates diversification benefits and currency hedging benefits for the U.S. investor and for investors from six other countries. The results support international diversification for risk reduction purposes but not as a way to increase returns. Hedging provides further risk reduction. However, it represents only about one-half the risk reduction that is provided by forming international portfolios. Ignoring transactions costs, the effect of currency hedging on investors' rates of return was to move their return closer to the average return that is obtained worldwide.

GLOBAL ACCOUNTING STANDARD STATEMENT: BASIS FOR INCREASED VALUE

Adoption of mental horizons of a global nature have prompted a variety of interests and developments. The trend will continue, especially in the areas of economics and business. This development has been accompanied by the globalisation and increased interest in international equity and credit investments and the development of currency, money, capital, and even commodities markets.