International Portfolio Research Articles

Analysing portfolio diversification opportunities in selected stock markets of North and South America and their impact on the textile sector: An empirical case study

This empirical study investigates the financial integration linkages among the sample stock markets of Canada, Mexico,United States (for both New York Stock Exchange, i.e. NYSE and NASDAQ), Panama, Brazil, Chile, Peru, Venezuela,Jamaica, Trinidad, and Tobago during the period from January 2001 to April 2019. This research study also examinesthe impact of selected stock market dynamics on the textile sector. International portfolio diversification has been animportant subject of research in financial fraternity since the emergence of Modern Portfolio Theory in 1952. This studyexamines the portfolio diversification opportunities in the 11 stock markets of Americas.International diversificationamong stock market indices has proven to be fruitful in the past. Certain tests have been used to determine opportunitiesfor diversification are correlation test, pairwise co-integration test, multiple co-integration test and granger causality test.The empirical results show that stock market indices share low correlation among other and they are not highlyco-integrated whereas results of Granger causality test exhibit an unidirectional relationship among few stock marketsin short run.

The international spillover effects of US monetary policy uncertainty

An extensive literature studies the international transmission of US monetary policy surprises (shifts in expected path of the policy rate). In this paper we show that changes in uncertainty around the expected path constitute an important additional dimension of spillover effects to global bond yields. In advanced countries, it is the term premium component of yields that responds to uncertainty. We find that this can be explained by an international portfolio balance mechanism. In contrast, for emerging countries it is the expected component of yields that reacts to uncertainty. This can be rationalized from a flight to safety channel. We find heterogeneity in the country-level response to uncertainty only in emerging countries and it is driven by the degree of financial openness. Finally, equity markets in both advanced and emerging countries also respond to US monetary policy uncertainty.

Impact of Brexit on Islamic stock markets: employing MGARCH-DCC and wavelet correlation analysis

PurposeThis paper aims to study the co-movement dynamics of Islamic equity returns to explain international portfolio diversification opportunities for investors having a heterogeneous stock holding period in light of Brexit.Design/methodology/approachThe authors use the following three recent methodologies: the multivariate generalised autoregressive conditional heteroskedastic-dynamic conditional correlations, continuous wavelet transforms and maximum overlap discrete wavelet transform. Dow Jones Islamic country-based indexes are used from 2 September 2013 to 31 December 2019.FindingsThere is a high correlation between the United Kingdom (UK) Islamic stock market return with the Canadian, USA, Malaysian and Indian implying lesser diversification benefits for the investors. However, the results tend to indicate that UK Islamic stock market investors who have allocated their investment in Sri Lanka, Kuwait, Japan and Turkey have enjoyed diversification benefits. Besides, there is a declining correlation between UK Islamic stock markets and other selected markets aftermath of Brexit. Turkey seems the most volatile stock over the period, appealing to risk-lover investors to gain from price changes. When the shock occurs in the financial sector, the volatility is mean-reverting faster than other markets in Sri Lanka. On the other hand, Malaysia appears to have the least volatility implying a stable financial sector.Research limitations/implicationsThe results tend to shed light on effective portfolio diversification benefits in light of the recent shock (Brexit) between the UK Islamic stock index and other selected indexes that vary from country to country depending on investment horizons. This critically confirms the significance of heterogeneity in investment horizons and provides significant inferences for portfolio diversification strategies.Originality/valueTo the best of the authors’ knowledge, this study is the first study investigating the Brexit effect on Islamic stocks, guiding Shariah sensitive investors in their diversification strategies, providing information to investors to consider the implications of this incident on Islamic stocks for future shocks.

Hedge and safe haven properties during COVID-19: Evidence from Bitcoin and gold

The COVID-19 pandemic has caused an unprecedented human and health crisis. The measures taken to contain the damage caused a global economic slowdown. Investors face liquidity pressures resulting from the general downturn in the financial markets, and might change their risk appetite. This paper reassesses the safe haven property of gold as a traditional asset, and Bitcoin which is gradually imposing itself as a new class of asset with unique characteristics. The empirical results, applied on major world stock market indices and currencies, and based on the multivariate asymmetric dynamic conditional correlation model, show the effectiveness of Bitcoin and gold as hedging assets in reducing the risk of international portfolios. Moreover, the analysis provides evidence that during the COVID-19 pandemic, gold is a weak safe haven for the considered assets, while Bitcoin cannot provide shelter due to its increased variability.

INVESTIGATION OF THE RELATIONSHIP BETWEEN TURKEY AND DEVELOPED STOCK MARKETS IN THE PANDEMIC PERIOD: ARDL BOUND TESTING APPROACH

The integration of stock markets is an essential issue for international investors who aim to make short and long term investments. This paper examines Turkey and developed stock markets co-movements during the pandemic. International portfolio diversification advantages are investigated for Turkish investors who have a portfolio in developed markets. For this purpose, the long-term relationship between stock markets is analyzed using the Autoregressive Distributed Lag (ARDL) bound test. The study covers January 2019 and April 2021, and this period is divided into two separate periods, pre-pandemic and pandemic. The results of ARDL bounds tests have not found a cointegration relationship between stock markets in both the pre-pandemic period and the pandemic period. Granger causality test results show that NIKKEI 225 (Japan), DAX (Germany), FTSE 100 (United Kingdom) and CAC 40 (France) are the cause of BIST 100 (Turkey) in the pre-pandemic period. However, Granger causality test results show that there is no causality relationship during the pandemic period. Turkish stock market investors investing in developed stock markets will benefit from portfolio diversification in the long term.

POTENTIAL FOR THE PORTFOLIO DIVERSIFICATION IN EMERGING MARKETS: A SURVEY OF EMPIRICAL EVIDENCE

Finding diversification opportunities in emerging markets presents continuous challenge for international investors. This is the case because diversification opportunities in emerging markets change as a result of change in the expected level, dynamics and direction of cross-country, cross-area and cross-assets correlations, as well as the expected (dis)appearance of volatility transmission across countries and areas. In order to provide the most up-to-date evidence on potential for the portfolio diversification in emerging markets, the author will use recent literature. According to the author’s findings, potential for portfolio diversification still exists in all emerging markets areas and the majority of individual emerging markets around the world. Additionally, portfolio diversification in different segments of an emerging financial market can also be beneficial to international investors. Due to the variability of key preconditions for international portfolio diversification, investors should frequently adjust their portfolio positions.

Examining Volatility Spillover Between Foreign Exchange Markets and Stock Markets of Countries such as BRICS Countries

The objective of this article is to examine the volatility spillover effect between the foreign exchange market and the stock market of Brazil, Russia, India, China and South Africa (BRICS) countries along with Japan as the developed country in the region, affecting the BRICS countries. Generalized Autoregressive Conditionally Heteroscedastic (GARCH) (1,1) method is used to study the volatility between the stock market and the foreign exchange market in selected countries, and asymmetric model, that is, Exponential Generalized Autoregressive Conditional Heteroscedasticity—EGARCH (1,1) is also used to investigate the presence of leverage effects in both stock market and foreign exchange market in selected countries. GARCH findings suggest a two-way volatility spillover between the stock market and foreign exchange markets for India, China and South Africa. In BRICS countries, volatility spillover from the currency market to the stock market is seen as more evident and robust as compared to spillover from the stock market to the currency market. A positive asymmetry in spillover is also observed from the foreign exchange market to the stock market. The findings of the study may provide valuable information to investors for decision-making in international portfolio investment and also for economic policymakers for their financial stability perspective.

CAUSALITY AND COINTEGRATION AMONG STOCK MARKET INDICES: A STUDY OF DEVELOPED MARKETS WITH SENSEX

The aim of this paper is to examine the existence of degree of interdependence between Sensex and various stock markets of the American and European regions. The study attempts to analyse the dynamic interactions among 22 global indices. The daily closing prices of indices were obtained from the respective stock exchange websites from January 2005 to May 2018.  The normality, stationarity, and causality of the time series were evaluated in the first section using statistical techniques such as the Jarque-Bera statistic, ADF test, and Granger Causality test. The second part of the approach focused on analysing the interdependencies of various stock markets, determining the degree of association, and measuring market efficiency using techniques such as Johansen's Cointegration test, Cross-Correlation test, and Hurst Exponent. The results indicate that there is a significant amount of interdependence between stock markets. It was also observed that there is an association between markets. This study also found bi-directional as well as uni-directional causality among the stock market indices. The study found that interdependence of markets leads to improvements in short-term as well as long-term returns/gains for investors possibly due to international portfolio diversification if there are stronger co-movements of prices across the markets. JEL Classification Codes: G15, F15, F21. &nbsp

CAUSALITY AND COINTEGRATION AMONG STOCK MARKET INDICES: A STUDY OF DEVELOPED MARKETS WITH SENSEX

The aim of this paper is to examine the existence of degree of interdependence between Sensex and various stock markets of the American and European regions. The study attempts to analyse the dynamic interactions among 22 global indices. The daily closing prices of indices were obtained from the respective stock exchange websites from January 2005 to May 2018.  The normality, stationarity, and causality of the time series were evaluated in the first section using statistical techniques such as the Jarque-Bera statistic, ADF test, and Granger Causality test. The second part of the approach focused on analysing the interdependencies of various stock markets, determining the degree of association, and measuring market efficiency using techniques such as Johansen's Cointegration test, Cross-Correlation test, and Hurst Exponent. The results indicate that there is a significant amount of interdependence between stock markets. It was also observed that there is an association between markets. This study also found bi-directional as well as uni-directional causality among the stock market indices. The study found that interdependence of markets leads to improvements in short-term as well as long-term returns/gains for investors possibly due to international portfolio diversification if there are stronger co-movements of prices across the markets. JEL Classification Codes: G15, F15, F21. &nbsp

Time-varying asymmetric tail dependence of international equities markets

In this paper, we use the skewed t copula with a DCC (Dynamic Conditional Correlation) model to capture the time-varying asymmetric tail dependence among MSCI US, Europe and Emerging markets. The empirical results show that it is important to take account of asymmetric tail dependence when measuring extreme tail risk and forming international portfolio. We find the emerging markets can provide a good contribution to diversifying tail risk. Meanwhile, compared with the normal copula and t copula, the skewed t copula can produce superior out-of-sample portfolio performance in minimizing expected shortfall.

Banks’ international assets and sovereign default risk

PurposeThis paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’ foreign exposure is an important determinant of sovereign default probability.Design/methodology/approachUsing data from the consolidated banking statistics (total foreign claims on ultimate risk basis) by the Bank of International Settlements, the author constructs a measure of bank international exposure to peer countries. This measure is then used as the target variable in a panel regression for sovereign credit default swaps. The model includes 15 European and non-European developed economies. Identification is discussed extensively in the paper.FindingsQuantitatively, a 1% increase in banks’ cross-border claims increases sovereign default risk by about 0.19%. The relationship is weaker when banks are more capitalised. On the other hand, governments are more vulnerable to credit risk spillovers from banks’ international portfolios when having higher debt to GDP ratios.Originality/valueTo the best of the author’s knowledge, this is the first paper that attempts explicitly to establish an empirical connection between banks’ international assets and sovereign default risk. To the author’s opinion, this paper represents a contribution to our understanding of how sovereign credit risk spills over across countries. It also extends significantly the existing literature on the determinants of sovereign risk (that primarily focused on fundamentals, market characteristics – such as liquidity – and global factors). This paper ultimately sheds some new light on the role of intermediaries in the international transmission of credit risk, also adding to today’s discussion about the linkages between banks and sovereigns.

Dynamic links between renewable energy, commodities, and financial stock markets: Implications for portfolio diversification

This paper investigates the dynamic links between renewable energy, commodities, and financial stock markets and analyzes the performance of renewable energy investment in an international portfolio diversification strategy across different financial market conditions. By using the dynamic spillover approach, the empirical results show that the renewable energy and oil markets are net emitters of shocks to stock markets. By applying the nonparametric stochastic dominance approach and comparing the optimal maximum Sharpe ratio (MSR) diversified portfolios, the results suggest that the renewable energy index can be a good substitute for traditional diversification, especially during tranquil periods.

Measuring contagion during COVID-19 through volatility spillovers of BRIC countries using diagonal BEKK approach

PurposeThe outbreak of the coronavirus disease 2019 (COVID-19) pandemic is an unprecedented shock to the BRICS (Brazil, Russia, India, China, South Africa) economy and their financial markets have plummeted significantly due to it. This paper adds to the recent literature on contagion due to spillover by uniquely examining the presence of pairwise contagion or volatility transmissions in stock markets returns of India, Brazil, Russia, China and USA prior to and during COVID-19 pandemic period.Design/methodology/approachIn this study, the generalised autoregressive conditional heteroskedasticity (GARCH) by Bollerslev (1986) under diagonal parameterization is used to estimate multivariate GARCH framework also known as BEKK (Baba EngleKraft and Kroner) model on stock market returns of BRIC nations and the US.FindingsThe empirical results show that the model captures the volatility spillovers and display statistical significance for own past mean and volatility with both short- and long-run persistence effects. Own volatility spillovers (Heatwave phenomenon) have been found to be highest for the US, China and Brazil compared to Russia and India. The coefficients indicate persistence of volatility for each country in terms of its own past errors. The highest and long-term spillover effect is found between US and Russia. The results recommend that Russia is least vulnerable to outside shocks. Finally after examining the pairwise results, it is suggested that the BRIC countries stock indices have exhibited volatility spillover due to the COVID-19 pandemic.Research limitations/implicationsThe study may be extended to include other emerging market economies under a dynamic framework.Practical implicationsResearchers and policymakers may draw useful insights on cross-market interdependencies regarding the spillovers in BRIC countries' stock markets. It also helps design international portfolio diversification strategies and in constructing optimal portfolios during COVID and in a post-COVID world.Originality/valueCOVID-19 has been an improbable event in the history of the world which can have a large impact on the financial economies across the emerging countries. This event can be deemed to be informative enough to measure the co-movements of the equity markets amongst cross-country return series, which has not been investigated so far for BRIC nations.

Comparison of linear and non-linear GARCH models for forecasting volatility of select emerging countries

PurposeSeveral empirical studies have proven that emerging countries are attractive destinations for Foreign Institutional Investors (FIIs) because of high expected returns, weak market efficiency and high growth that make them attractive destination for diversification of funds. But higher expected returns come coupled with high risk arising from political and economic instability. This study aims to compare the linear (symmetric) and non-linear (asymmetric) Generalized Autoregressive Conditional Heteroscedasticity (GARCH) models in forecasting the volatility of top five major emerging countries among E7, that is, China, India, Indonesia, Brazil and Mexico.Design/methodology/approachThe volatility of financial markets of five major emerging countries has been empirically investigated for a period of two decades from January 2000 to December 2019 using univariate volatility models including GARCH 1, 1, Exponential Generalized Autoregressive Conditional Heteroscedasticity (E-GARCH 1, 1) and Threshold Generalized Autoregressive Conditional Heteroscedasticity (T-GARCH-1, 1) models. Further, to examine time-varying volatility, the distinctions of structural break have been captured in view of the global financial crisis of 2008. Thus, the period under the study has been segregated into pre- and post-crisis, that is, January 2001–December 2008 and January 2009–December 2019, respectively.FindingsThe findings indicate that GARCH (1, 1) model is superior to non-linear GARCH models for forecasting volatility because the effect of leverage is insignificant. China has been considered as most volatile, whereas India is volatile but positively skewed and Indonesia is the least volatile country. The results can help investors in better international diversification of their portfolio and identifying best suitable hedging opportunities.Practical implicationsThis study can help investors to construct a more risk-adjusted returns international portfolio. Further, it adds to the scant literature available on the inconclusive debate on the choice of linear versus non-linear models to forecast market volatility.Originality/valueEarlier studies related to univariate volatility models are mostly applications of the models. Only few studies have considered the robustness while applying the models. However, none of the studies to the best of the authors’ searches have considered these models for identifying the diversification opportunity among the emerging countries. Hence, this study is able to derive diversification and hedging opportunities by applying wide ranges of the statistical applications and models, that is, descriptive, correlations and univariate volatility models. It makes the study more rigorous and unique compared to the previous literature.

Portfolio rebalancing in times of stress

This paper investigates time variation in the dynamics of international portfolio equity flows. We extend the empirical model of Hau and Rey (2004) by embedding a Markov regime-switching model into the structural VAR. The model is estimated using monthly data from 1995 to 2018, on equity returns, exchange rate returns, and equity flows between the United States and advanced and emerging market economies. We find that the data favor a two-state model where coefficients and shock volatilities switch jointly. In the VAR for flows between the United States and emerging market economies, the estimated states match periods of low and high financial stress, both in terms of the timing of regime switching and in terms of their volatility characteristics. Our main result is that for equity flows between the United States and emerging markets rebalancing dynamics differ between episodes of high and low levels of financial stress. A switch from the low- to the high-stress regime is associated with capital outflows from emerging markets. Once in the high-stress regime, the response of capital flows to exchange rates and stock prices is smaller than in normal (low-stress) periods.

A three-tiered nested analytical approach to financial integration: The case of emerging and frontier equity markets

This study investigates the patterns of integration of emerging and frontier equity markets with the US stock market during the period 2002–2014 characterised by financial turmoil and instability. To add rigour to the study, to overcome the limitations of simple correlation analysis of integration, and to produce more robust results, we propose a nested analytical approach based on a three-tiered research design. The first level uses the smooth transition conditional correlations among the US, emerging, and frontier markets. The second tier uses the results of the smooth transition approach to creating different international portfolios, which, based on alternative investment strategies, account for the time-varying correlations among markets and exploit the scope of international diversification with less integrated markets. Finally, the last tier of analysis uses returns and risks of these different international portfolios and applies structural models to explore characteristics and integration patterns in turbulent times. The three nested approaches indicate that the global financial crisis has produced a permanent increase in the degree of integration among the US and frontier markets. Conversely, the crisis's effect seems to have been only temporary in the case of integration among the US and emerging equity markets. Despite the changes brought by the crisis, the degree of integration among emerging markets and the US market is considerably more significant than the degree of integration among frontier and US markets. The novelty of this methodological approach enables us to provide some original contributions and empirical results that are robust and relevant to investors in international markets.

International Portfolio Investments with Trade Networks

What determines the composition of international portfolio investments remains an open question in international finance. In this paper, I propose a theory of international portfolio choice where trade networks play a key role. I solve in closed form for the optimal equity and bond portfolio investments in a multi-country model with arbitrary global input - output linkages and taste differences. I show that a measure of international demand exposure, called the “International Domar Weights” (IDWs), is key in determining international equity portfolios. The IDWs extend the closed-economy “Domar weights” to the international setting and capture countries' interdependence through both direct and indirect trade linkages. Using data from the World Input - Output Database (WIOD) and Coordinated Portfolio Investment Survey (CPIS), I apply the framework to a network of 43 major developed and emerging economies and obtain four main results. First, the theoretical network portfolio is a significant predictor and explains almost half of the variation in international bilateral portfolio investments. The significance of the network portfolio is robust to controlling for gravity factors (market capitalization, distance, EU membership, etc.). Second, including the network-based portfolio in a gravity model for assets resolves the puzzle of why distance matters for asset trade at all. Third, indirect trade linkages matter for portfolio determination, highlighting the need to explicitly account for trade in intermediate inputs. Finally, the model predicts both the levels and the changes in equity home bias that have occurred since 2000.

COVID-19 pandemic and global financial market interlinkages: a dynamic temporal network analysis

ABSTRACT The present study investigates the changes in G20 stock market dynamics and their interlinkages in the aftermath of COVID-19. It utilizes the Detrended Cross-Correlation Analysis (DCCA) along with the network and complexity theories for detecting the contagion effect of the pandemic on the stock markets. We find that both advanced and emerging stock markets, departing from their pre-crisis structures, form a tightly coupled close community after the disease outbreak – except for China that distanced itself from the rest of the cohort. This indicates that COVID-19 has caused contagion in the global equity market, which has increased the risk to international portfolio diversification benefits. The adoption of the Network theory for contagion detection technique augments the detailed understanding of the structural changes and their interlinkages among the stock markets in a more comprehensive way.

International portfolio diversification and genetic relatedness

The purpose of this paper is to shed some light on how relatedness between counterparties can explain investment behavior, specifically how much can investor’s inherited traits influence the exchange of capital. We use the genetic distance index and regress it against the foreign bias measure on pairs from 40 countries on a time period from 2001-2016. We identify that the prior exerts a significant impact on foreign investment decision, even when controlling for previous documented determinants of foreign bias. These findings reflect that international portfolio allocation is obstructed by the cultural wedge created between source and destination country, since relative difference in these characteristics disturb the flow of equity investments across markets, which ultimately hinder diversification.

Managing Political Risk in International Portfolios

We show that internationally diversified portfolios carry sizeable political risk premia. Using a portfolio selection model with tail risk, we obtain political efficient frontiers from skewed return distributions to manage political risk, and design an inference test to draw conclusions. We find that politically hedged international portfolios of US investors realize performance gains against a broad market index (and other benchmarks). Currency hedging does not eliminate political risk. The diversification gains increase for long-horizon investors. Qualitatively identical results are obtained for Eurozone and Japan. Our findings inform the home equity bias puzzle literature, and are robust to several model specifications.