Time-Varying Correlations and Optimal Allocation in Emerging Market Equities for Australian Investors: A Study Using East European Depositary Receipts

Transcription

1 Tme-Varyng Correlaons and Opmal Allocaon n Emergng Marke Eques for Ausralan Invesors: A Sudy Usng Eas European Deposary Receps Auhor Gupa, Rakesh, Jhendranahan, Thadavlll Publshed 2008 Journal Tle Inernaonal Research Journal of Fnance and Economcs Copyrgh Saemen 2008 EuroJournals Publshng, Inc. The aached fle s reproduced here n accordance wh he copyrgh polcy of he publsher. Please refer o he journal's webse for access o he defnve, publshed verson. Downloaded from hp://hdl.handle.ne/10072/36488 Lnk o publshed verson hp:// Grffh Research Onlne hps://research-reposory.grffh.edu.au

2 Inernaonal Research Journal of Fnance and Economcs ISSN Issue 18 (2008) EuroJournals Publshng, Inc hp:// Tme-Varyng Correlaons and Opmal Allocaon n Emergng Marke Eques for Ausralan Invesors: A Sudy Usng Eas European Deposary Receps Rakesh Gupa Rakesh Gupa, School of Commerce, Faculy of Busness & Informacs Cenral Queensland Unversy, Bruce Hghway Rockhampon, QLD 4700, Ausrala E-mal: R.gupa@cqu.edu.au Tel: , Fax: Thadavlll Jhendranahan Deparmen of Fnance, Opus College of Busness, Unversy of S. Thomas 2115 Summ Avenue, MCH316, S. Paul, MN 55105, USA E-mal: T9JITHENDRAN@shomas.edu Tel: Absrac Ausralan sock marke has lower marke capalzaon compared o ha of many oher OECD counres and Ausralan nvesors can reduce her overall porfolo rsk by dversfyng no eques from oher markes. Choosng sock markes wh low correlaons wh he domesc marke can ncrease he porfolo dversfcaon benefs. For Ausralan nvesors, Eas European sock markes are one such asse class and hs paper sudes he dversfcaon benefs o Ausralan nvesors from dversfyng no he Eas European eques. Snce he correlaons beween asse reurns are me-varyng, usng uncondonal esmaes of correlaons n a porfolo opmzaon model can resul n msallocaon of asses. To allevae hs problem, hs sudy uses mulvarae GARCH (Generalzed Auoregressve Condonal Heeroskedascy) models o esmae me varyng correlaons. The asses used n he porfolo opmzaon model for hs sudy comprse of Amercan Deposary Receps (ADRs), 11 Russan, 5 Polsh, 2 Hungaran and 1 Czech Republc eques and All Ordnares Ausralan ndex. Ex-pos reurn calculaons show ha unresrced porfolos of Ausralan ndex wh he ADRs ouperform he reurns from holdng only Ausralan socks. Wh nvesmens resrced o 10% n ADRs here s no sascally sgnfcan dversfcaon benefs bu wh 20% nvesmen n ADRs here s evdence of sascally sgnfcan dversfcaon benefs. Keywords: F37 Inernaonal Fnance, G15 Inernaonal Fnancal Markes 1. Inroducon The objecve of nernaonal dversfcaon s o mprove he rsk/reurn rade-off for nvesors. The benefs of nernaonal dversfcaon as such are well documened n he academc leraure. Grubel (1968) found ha beween 1959 and 1966, U.S. nvesors could have acheved superor rsk and reurn

3 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 128 opporunes by nvesng par of her porfolo n foregn equy markes. Levy and Sarna (1970) analyzed nernaonal correlaons for he perod and demonsraed he dversfcaon benefs from nvesng n developed and developng equy markes. Grubel and Fadner (1971) showed ha beween 1965 and 1967 ndusry correlaons whn counres exceed ndusry correlaons across counres. Invesors are conscous of he fac ha nernaonal socks have dfferen characerscs so ha by dversfyng beween dfferen counres or ndusres n counres, he performance of he porfolo can be mproved. Invesng n nernaonal markes dffers from domesc marke nvesmen n hree mporan ways (Lessard, 1976). Frs, he covarances among asses whn a domesc marke are much hgher han he covarances among dfferen markes. Second, barrers mposed by axaon, currency conrols, or nvesor radon may furher segmen naonal markes suffcenly such ha asses are prced n a domesc raher han an nernaonal mleu. Fnally, exchange raes beween dfferen currences devae from each oher gvng rse o currency exposure on nernaonal porfolos. Revew of heorecal and emprcal research no nernaonal dversfcaon ndcaes, despe ncreasng globalsaon, benefs accrue o nvesors holdng socks lsed n oher counres. These benefs arse, n par, from dfferences beween counres n he naure of her real economes. The greaes dfference n real economy srucures are beween he emergng and developed markes. Thus, on heorecal grounds, emergng marke nvesmens should provde a means by whch an nvesor can acheve hgher rsk-adjused reurns for a dversfed porfolo. Ibrahm (2006) found here are sll poenal benefs n dversfyng no emergng markes for an nvesor wh long-erm nvesmen horzon. Hgher volaly of he emergng markes have been of concern for he academcs and praconers n erms of accessng nernaonal dversfcaon benefs, a model ha provdes more accurae measure of correlaons may allevae some of hese concerns. Dynamc Condonal Correlaon (DCC) GARCH model s one such model ha helps o esmae correlaons more accuraely. Recen workng paper by Anonou, Olus and Paudyal (2006) look a he dversfcaon benefs of home-made dversfcaon sraeges usng DCC model and fnd ha drecly dversfyng no foregn markes does no yeld beer resuls as compared wh porfolo consruced usng Euro zone as he home marke. Our research hough uses DCC model bu has an enrely dfferen focus. We look a he dversfcaon benefs for an Ausralan nvesor and because of s smaller sze and dfferen srucure an Ausralan nvesor may be exposed o facors dfferen from an nvesor from a larger marke 1. Researchers have also argued ha smlar benefs could be acheved by nvesng no socks of mulnaonal companes as her reurns are expeced o be more closely correlaed wh he global facors han wh ha of he domesc facors. However, reurns of Ausralan mulnaonal companes are found o be closely correlaed wh he domesc reurns and less wh he global reurns (Wrgh and McCarhy 2002). Ths could be because of he smaller sze of Ausralan mulnaonal companes. Emprcal research of Schmukler (2004) and L, Sarkar and Wang (2003) also ndcae ha here are sll benefs o be realzed n dversfyng nernaonally because world fnancal markes are sll no fully negraed. The dfferences beween emergng and developed economes are refleced n fnancal markes by he key characerscs of reurn, rsk, and correlaons, wh correlaons as he chef ndcaor for dversfcaon advanages. Increasng marke negraon has sgnfcanly reduced he dversfcaon benefs from a porfolo drawn from developed markes bu has no nfluenced he benefs from emergng marke nvesmens o he same degree (Harvey, 2000). Whle hese dfferences n he real and fnancal secors of he emergng markes compared o hose of he developed markes connue, he dversfcaon benefs n nvesng no hese markes are lkely o connue. Research, hus far has concenraed n esng he benefs of he dversfcaon no larger emergng markes ha have comparavely beer developed markes. In hs sudy we exend hs argumen o nclude some of 1 In case of Anonou, Olus and Paudyal, whole of Euro zone s consdered as he home marke.

4 129 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) he markes ha are sll no commonly ncluded n he emergng marke dversfcaon sudes. The benefs of dversfyng no hese markes could be dfferen as he dfferences n he economc srucures of hese markes are expeced o be more pronounced. Research n nernaonal dversfcaon, from he perspecve of Ausralan nvesors s lmed. Allen and Macdonald (1995) suded he dversfcaon benefs avalable o he Ausralan nvesor over he perod 1970 o 1992 and found ha for mos par wse porfolos, here exsed poenal longrun porfolo dversfcaon gans. Smlar resuls are repored by Wason and Dcknson (1981), Mchell, Wapnah and Izan (1988) and Izan, Jalleh and Ong (1991). Gupa (2006) n a revew of leraure n he area of nernaonal dversfcaon from he perspecve of Ausralan nvesor and fnd on heorecal grounds Ausralan nvesors should benef by dversfyng no emergng markes. Marke negraon as such s no sac and may vary over me. Bekaer and Harvey (1995) used a condonal regme swchng model o sudy he level of negraon beween equy markes of several counres and found ha he level of negraon changes wh me. Adler and Q (2002) found ha he marke negraon s affeced by global and domesc facors as well. In recen years, here are several papers ha look no he me-varyng naure of reurn correlaons and facors ha cause he changes n correlaons. Yang (2005) suded he correlaons beween Japan, Tawan, Sngapore, Hong Kong and Souh Korea and found ha reurn correlaons vared consderably durng he perod of sudy and correlaons ncreased durng he bear marke perods. Jhendranahan (2005) suded he correlaons beween he U.S. and Russan equy markes and found ha changes soveregn cred rsk, world energy prces and exchange rae as he reasons for he changes n correlaons. The mos popular mehod o esmae me-varyng correlaons s o use a movng average specfcaon wheren correlaons are esmaed usng a movng wndow of me. The weakness of hs mehod s ha gves equal wegh o all he observaons durng he me perod used n he movng average calculaons. The oher mehod used o calculae me varyng correlaons s o use mulvarae GARCH models. Early models of hs caegory were based on Consan Correlaon Model of Bollerslev (1990). The man weakness of hese models s he assumpon ha correlaons were consan. The second se of models n hs caegory s based on Kroner and Ng (1998). These models, hough heorecally sound, lacked compuaonal ease as hese models requre esmang oo many coeffcens a he same me. Engle (2002) nroduced anoher varan of he mulvarae GARCH model called Dynamc Condonal Correlaon Model (DCC), whch combned heorecal appeal of me-varyng correlaons and he compuaonal flexbly of he unvarae models. Ths sudy wll use hs model o esmae me varyng correlaons beween Ausralan equy ndex and he foregn asses. Wh capal markes becomng more negraed, he scope for explong any neffcences may be dmnshng rapdly as fnancal analyss denfy he excess reurns and hen arbrage hem away (Fraser, Hellar and Power, 1992). However, here may be heorecal jusfcaon for poenal gans from nernaonal dversfcaon as nvesors gan access o shares n ndusres whch are no represened or are hnly represened n he domesc marke. There are wo ssues ha hs paper ams o address based on he argumen ha he lower correlaons occur from he dfferences n he underlyng economc srucures of he wo markes (domesc marke of he nvesor and he foregn marke). Frs, he me-varyng correlaons beween Ausralan, emergng and developed markes are suded o denfy he markes ha mgh offer he maxmum dversfcaon poenal for Ausralan nvesor. Second, usng a sample of emergng marke eques, opmal porfolos are consruced and ex-pos reurns of hese are compared wh ha of he Ausralan equy reurns. Based on he analyss of correlaons, he eques from former Communs counres of Easern Europe are chosen as a sample of emergng marke eques for esng he dversfcaon benefs. Afer he break up of he Sove Unon, marke economy s developng n hese counres and eques from here are avalable for nernaonal nvesors. Several socks wh large marke capalzaons from hese counres are lsed as Amercan Deposores Receps and Global Deposory Receps n

5 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 130 he U.S. and European sock exchanges and are acvely raded and can easly be avalable for nvesmen by Ausralan nvesors 2. Ths sudy covers he perod from November 1997 o Augus 2005 and uses All Ordnares Index for Ausralan equy reurns and he reurns of deposory receps from Russa, Hungary, Czech Republc, and Poland. Deposory Receps (DRs) from hese counres are chosen nsead of broad based counry ndces for he followng reasons. Tradable ndces are no avalable n all of hese counres and DRs provde a good proxy for he marke as hese DRs are creaed wh he socks of companes whch form a subsanal par of he marke capalzaon n hose counres. The res of he paper s organzed as follows. Secon 2 descrbes he emprcal mehodology and daa used n hs paper. Resuls of he emprcal analyss are presened n Secon 3 and he conclusons of hs paper are gven n Secon Emprcal Mehodology and Daa In porfolo opmzaon models, he objecve s o maxmze he reurn and mnmze he rsk. The expeced reurn of a porfolo s he weghed average of he reurns of ndvdual secures n he porfolo and he weghs are he proporon of each of he secures n he porfolo, whch can be expressed as follows: N P = X R = 1 R where X s he wegh of he h secury n he porfolo and R s he expeced reurn of ha asse. The sandard devaon of a porfolo can be expressed as: N = 1 N N σ = X σ + X X σ (2) P = 1 k = 1 k j, k where σ 2 s are he varances and σ,k s he covarance beween he wo secures and k. The sandard mehod of opmzaon s o fnd a se of porfolos whch wll gve he maxmum reurn for a gven level of rsk. Ths se of porfolos s called he effcen se of porfolos and based on her ndvdual rsk preferences, nvesors can choose a specfc porfolo from hs se of opmal porfolos. Mahemacally, he opmzaon problem can be saed as follows: N = 1 N N Mn σ = X σ + X X σ (3) P = 1 k = 1 k j, k Subjec o he followng consran: N X = 1 (4) = 1 Snce shor sellng s no allowed or severely resrced n many of he emergng markes, he followng addonal consran s mposed on he opmzaon model: 0 X 1 (5) To capure he me-varyng naure of varances and covarances, he DCC model of Engle (2002) s used n esmang he correlaons. DCC has a wo sep procedure for esmang he condonal varances and correlaons. I s assumed ha he reurns of he 20 asses used n consrucng he porfolos n hs paper are normally dsrbued wh zero mean condonal on he nformaon avalable a -1. E ( r ) ~ N(0, H ) (6) 1 (1) 2 Ausralan nvesors can nves no ADRs eher drecly by conacng brokers n Amerca and recenly ADRs lsed on he USA sock exchanges are also avalable hrough brokers n Ausrla.

6 131 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) where r s he 20x1 vecor of asse reurns a me and H s he condonal covarance marx expressed as: H D R D (7) where H s he 20x20 condonal covarance marx, R s he condonal correlaon marx and D s a dagonal marx wh he me-varyng sandard devaons n he dagonal. In he frs sep he followng unvarae GARCH model s used o esmae he dagonal elemens σ of D usng he followng GARCH(1,1) specfcaon σ = γ + α r 1 + β σ 1 (8) The condonal reurn of each of he asses s sandardzed by dvdng by s sandard devaon obaned n he prevous sep. Ths gves he followng sandardzed vecor of reurns: E 1( ) ~ N(0, R ) (9) Correlaon beween any wo asses and j can be wren as: E 1(, j, ) ρj, = = E 1(, j, ) (10) 2 2 E 1(, ) E 1( j, ) Usng a GARCH(1,1) specfcaon, he covarance beween he random varables can be wren as: qj, = ρ j + α (, 1 j, 1 ρ j ) + β ( qj, 1 ρ j ) (11) The uncondonal expecaon of he cross produc s ρ, whle for he varances s ρ j = 1 The correlaon esmaor s: qj, ρ j, = (12) q, q jj, Ths model wll be mean reverng f α + β < 1. The marx verson of hs model can hen be wren as: ' Q = S( 1 α β ) + α( 1 1 ) + βq 1 (13) where S s he uncondonal correlaon marx of he dsurbance erms andq = q, j,. The log lkelhood for hs esmaor can be wren as: T 1 ' 1 L = ( nlog(2π ) + 2log D + log R + R ) (14) 2 = 1 In he second sage of he esmaon he above lkelhood esmaor s used n esmang he parameers of equaon (10) 3. The above model s used n esmang he correlaons beween he Ausralan equy reurns and hose of developed and emergng markes. As dscussed earler, hs paper res o fnd he maxmum dversfcaon benef for he Ausralan nvesor by lookng a possble emergng marke socks ha mgh have he lowes correlaon wh he Ausralan socks. The prelmnary analyss showed ha he sock markes from he Eas European counres have one of he lowes reurn correlaons wh he Ausralan equy marke. Even hough many of he Easern European equy markes are open o foregn nvesors, due o legal and regulaory barrers, s dffcul for Ausralan nvesors o nves drecly n hese markes. Hence, s necessary o fnd socks ha are relavely easly accessble by Ausralan nvesors and seled for Amercan Deposary Receps (ADRs) of nneeen socks from Czech Republc, Hungary, Poland, and Russa. There are several ways of cross-lsng socks n foregn markes, bu he mos commonly used mehod s by ssung DRs. In a DR program, an nermedary buys he underlyng domesc sock and j 3 The sascal program RATS s used n acual esmaons.

7 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 132 ssues agans deposary receps denomnaed n foregn currency n a foregn marke. The mos common ype of DR s Amercan Deposary Recep (ADR). One of he requremens for ssung ADR s ha he ssung frm has o follow he U.S. Secures and Exchange Commsson s (SEC) gudelnes on dsclosure. Dependng on he level of dsclosure and wheher he frm s usng he ADR o rase new equy, hese ADRs are classfed no hree levels. Level I s he leas expensve and has relavely less srngen dsclosure requremens, bu can only be raded n he over-he-couner (OTC) marke n he U.S. and canno be used o rase new capal. Level II ADRs are allowed o rade n organzed exchanges n he U.S., bu he ssung foregn frm has o undergo full dsclosure requremens as spulaed by SEC. Level II ADRs also canno be used o rase new capal. Wh a Level III ADR, he ssung frm can rase new capal and ls he ADR n an organzed exchange n U.S., bu has o provde o he SEC fnancal saemens prepared accordng o he U.S. Generally Acceped Accounng Prncples (GAPP) or subm a dealed summary of he dfferences n fnancal reporng beween home and he U.S. A foregn frm ha would lke o rase capal whou meeng he full dsclosure requremens can do so by usng prvae placemens under Rule 144A of SEC. These prvae placemens have a lmed secondary marke; only Qualfed Insuonal Invesors 4 (QIBs) are allowed o rade hese prvae placemens. One of he oher developmens n he 144A marke s he creaon of Global Deposary Receps (GDRs). Some of he U.S. prvae placemens are ssued for global nvesors and hen raded n markes ousde he U.S., predomnanly n London and several German exchanges. These DRs for sale ousde he U.S. are ssued under Regsraon S provson and can be complemenary o a 144A ssue n he U.S. Snce hese ADRs are raded n he U.S., London, and Germany, s assumed ha hese are avalable for Ausralan Invesors. Snce he Easern European ADRs are avalable only from he md 1990s, s necessary o lm he me perod covered by hs sudy o November 1997 o Augus In London and he U.S., ADRs are quoed n U.S. dollars, whle n Germany he same are quoed n euros. Weekly prces for he nneeen ADRs are obaned n U.S. dollars and convered o Ausralan dollars usng he approprae exchange rae. For he Ausralan equy marke he Ausralan All Ordnary Index s used as he proxy. All daa for hs sudy s obaned from Bloomberg. The DCC esmaes are made wh ses of fve year rollng wndows, bu o capure he mevaryng naure of varances and covarances, he end of he perod values of he same are npu no he porfolo opmzaon model. For example, usng he DCC model one can esmae 260 varances and correlaons for a perod of fve years. Bu for esmang he effcen se of porfolos, only he varances and correlaons for he las week of he sample perod s used. 5 Weekly averages for he fve year perod are used as he proxy for expeced reurns n he porfolo opmzaon model. 6 Usng he above procedure, he weghs of he ndvdual socks n each of he effcen porfolos s calculaed. Usng hese weghs and he acual reurns of each of he nneeen DRs and he Ausralan ndex for perods of one-monh, hree-monhs, and sx-monhs from he dae when he effcen porfolo s creaed, ex-pos reurns of he effcen se of porfolos are calculaed for each of he sxy monhs for whch effcen ses were calculaed. The performance of effcen porfolos compued usng he DCC mehod are hen compared o ha of he Ausralan ndex usng he followng regresson equaon: = α + βdummy + R j, j, j, (15) Where R j, s he pooled ex-pos reurns of all eleven effcen porfolos for a perod one, hree and sxy monhs and Dummy j, s a dummy varable, whch s 1 f he porfolo wh emergng marke A QIB s defned as a frm ha has a leas US$100 mllon avalable for nvesmens. Currenly here are 4,000 QIBs and hey rade on he 144A placemens usng he closed elecronc sysem called PORTAL (Prvae Offerngs, Resales, and Tradng hrough Auomaed Lnkages). For example, for he me perod from 1/3/00 o 12/27/04, he varances and correlaons used were aken for he las week of he me perod, whch s 12/27/04. Ths way s possble o capure he full exen of he me-varyng naure of hese varables as exsed a he me of consrucon of he porfolo. Snce he daa sars only from November 1997, for he frs monh he number of observaons was only 111, and for he second monh 115, ec. From monh 34 onwards, we had he full se of fve year daa (252 weekly observaons).

8 133 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) ndces ncluded n and 0 f s Ausralan ndex only. If he regresson coeffcen β s sgnfcan, hen ndcaes ha here s a dfference n he ex-pos performance of he porfolos. The value of hs varable s also he dfference beween he ex-pos reurns of porfolos. 3. Resuls Inally hs paper ess he correlaons of equy ndces from emergng markes and developed markes wh ha of he Ausralan ndex usng he DCC model for he enre me perod of hs sudy. The resuls of he correlaons of emergng marke ndces wh ha of he Ausralan ndex are gven n Table 1. The average correlaon of all nneeen emergng markes wh Ausralan ndex was , wh Chna havng he lowes average correlaon of and Peru he hghes average correlaon of Low correlaon beween he Chnese equy and he Ausralan eques can possbly be explaned by he resrcons on foregn nvesors n Chnese equy markes and he exsence of dual class of eques n ha counry. Explanng he hgh correlaon beween Peru and Ausralan ndces s more dffcul. One possble explanaon s ha he equy marke n Peru s domnaed by frms n he exracve ndusres and a szable presence of smlar frms n he Ausralan equy marke may have conrbued o he hgh correlaon. Oher counres wh low average correlaons wh Ausrala are Argenna, Indonesa, Malaysa, and Czech Republc. Ou of hese four counres, he frs hree had gone hrough consderable economc urmol durng he perod of sudy, whch mgh have conrbued o he low correlaon wh he Ausralan eques. The average correlaons beween he developed markes and he Ausralan equy ndex are gven n Table 2. As expeced, he average correlaons beween he nneeen developed equy marke ndces and he Ausralan ndex s , whch s nearly double ha of he emergng markes. The counres wh low average correlaon wh he Ausralan eques are smaller economes n Europe such as Ausra, Denmark, and Porugal. Large developed markes had average correlaons close o 0.5. Ths hgh correlaon mgh reduce he dversfcaon benef o Ausralan nvesors who nves n hose counres. The ADRs ncluded n he sudy are lsed n Table 3, whch nclude 11 ADRs from Russan, 5 from Poland, 1 from Czech Republc, and 2 from Hungary. The descrpve sascs of he weekly reurns for he 19 ADRs, and Ausralan ndex ncluded n he sudy are gven n Table 4. Ou of 19 ADRs 11 have posve mean reurns, 8 have negave mean reurns; he Ausralan ndex has posve mean reurn. All he ADRs have a hgher sandard devaon as compared o he Ausralan ndex suggesng a hgher rsk as compared wh he Ausralan ndex. Skewness, Kuross and Jarque-Bera sascs for ADRs ndcae ha hese ADRs do no have normal dsrbuon. Average correlaons of each of he ADRs wh he Ausralan ndex are gven n he Table 5. The resuls ndcae a low correlaon of Ausralan ndex wh each of he ADRs, suggesng a poenal for dversfcaon benefs n dversfyng no hese eques. Summary sascs of ex-pos reurns of effcen porfolos creaed wh ADRs and Ausralan ndex, as well as Ausralan ndex are presened n Table 6. For each of 60 monhs, one mnmum varance porfolo and en effcen porfolos are creaed and he ex-pos reurns of each of hese porfolos are calculaed for perods of one-monh, hree-monhs and sx-monhs. Furhermore, hese porfolos are dvded no wo groups based on he sandard devaons of he effcen porfolos. For each monh, he sample s dvded no a se of low rsk porfolos comprsng mnmum varance porfolo and fve of he leas varance porfolos and anoher se of hgh rsk porfolo comprsng fve porfolos wh he maxmum rsk. The resuls of regressons usng equaon (15) are gven n Table 7. Pooled ex-pos reurns of effcen porfolos are regressed agans he dummy varable whch has a value of one for hose porfolos ha conan emergng marke ndces. Three ses of regressons are made; one for he oal sample, one for he low rsk porfolos, and one for he hgh rsk porfolos. The resuls ndcae ha he effcen porfolos creaed wh emergng marke ndces clearly domnae he reurns of Ausralan

9 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 134 ndex alone. Ths shows ha Ausralan nvesors can acheve sascally sgnfcan hgher reurns by dversfyng her porfolos o nclude emergng marke socks. Even hough unresrced opmzaon may look aracve, many nvesors are relucan o dversfy more han a ceran percenage of her asses no emergng marke eques. Table 8 shows he weghs of he dfferen ADRs whn he effcen porfolos. As can be seen from hs able, he weghs of he ndvdual ADR can vary from 0 o 0.6 and of Ausralan ndex from 0 o 0.3, whch ndcaes ha n a ceran effcen porfolos he wegh of Ausralan ndex could be zero and 100% of he nvesmens could be n ADRs. Based on he common pracce n he porfolo managemen pracce, called pruden man rule derved from he argumen ha a porfolo manager s usually rsk averse and wll no be wllng o dversfy away from he domesc secures, despe he fac ha porfolo opmzaon models sugges hgher nvesmen n foregn eques. Ofen hs ranslaes no resrcng foregn equy share o a ceran proporon of he oal porfolo. Ths proporon s ofen based on he marke pracce or arbrarly decded by he porfolo manager based on hs/her rsk averson. Followng hs, we es he porfolo dversfcaon benefs wh resrcons on he maxmum amoun ha can be nvesed n ADRs. The dversfcaon benefs wh he nvesmen n ADRs resrced o 10% and 20% of he oal nvesmen are esed. Wh he nvesmen n ADRs resrced o 10% he porfolos wh ADRs do no yeld sascally sgnfcan hgher reurn whle allowng up o 20% nvesmen n ADRs here s some ndcaon of dversfcaon benefs. The resuls of ex-pos performance of porfolos wh nvesmen up o 20% n ADRs are gven n Table 9. Ex-pos reurns of hese porfolos are calculaed as n he case of unresrced porfolos and compared wh he ex-pos reurns of he All Ausralan porfolo for perods of one, hree, and sx monhs. Resuls ndcae ha here are benefs n dversfyng no hese ADRs wh a resrcon of 20% no he ADRs and specfcally for he sx monh porfolos. Transacons coss n he emergng markes are lkely o be hgher han n he developed markes, Bekaer e al (1997) esmae 1.1% ransacons coss for nvesng n he emergng markes and smlar coss are consdered by Kargn (2002). Afer adjusng for 1.1% ransacons coss, he benefs are sll sgnfcan a 20% nvesmens n ADRs. 4. Conclusons Ths paper aemps o esmae dversfcaon benefs ha can accrue o an Ausralan nvesor by dversfyng no he former Sove bloc counres hrough he U.S. lsed Amercan Deposory Receps (ADRs). Over he years, praconers and academcans have looked no he benefs of dversfcaon no he nernaonal markes and as he world markes are negrang, he benefs of dversfcaon no nernaonal markes are dmnshng. Maxmum benefs of dversfcaon are derved n he markes whch are segregaed wh he developed markes. In hs paper we sugges usng ADRs as an alernave o drecly nves n hese markes and fnd ha low level of correlaons beween hese markes and Ausrala offer dversfcaon opporunes for he nvesors. Relavely hgh reurns and low correlaons offer beer dversfcaon benefs, whle he hgh varably n he equy reurns of hese markes requre beer economerc models o capure he me-varyng naure of he varances and correlaons. The use of DCC model n esmang correlaons has shown o mprove he porfolo opmzaon model. Unresrced dversfcaon no Eas European ADRs offer he mos dversfcaon benefs bu even wh resrced dversfcaon here are benefs and hese benefs can be praccally realzed usng ADRs as a vehcle for dversfcaon.

10 135 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) References [1] Adler, M. and Q, R. (2003). Mexco s Inegraon no he Norh Amercan Capal Marke, Emergng Markes Revew, 4, [2] Allen, D. E. and MacDonald. G. (1995). The Long-run Gans From Inernaonal Equy Dversfcaon: Ausralan Evdence From Conegraon Tess, Appled Fnancal Economcs, 5, [3] Anonou, A. Olus, O. and Paudyal, K. 2006, Is Inernaonal Porfolo Dversfcaon Relevan for he Euro zone nvesor?, workng paper of Cenre for Emprcal Research n Fnance, Durham Busness School, Unversy of Durham, vewed on 18 h July 2008, hp://papers.ssrn.com/sol3/papers.cfm?absrac_d= [4] Bekaer, G. and C. R. Harvey (1995). Tme-varyng World Marke Inegraon, Journal of Fnance 50, [5] Bekaer, G, Erb, GB, Campbell, RH & Vskana, TE 1997, Wha Maers for Emergng Markes Invesmens, Emergng Markes Quarerly, vol.1, pp [6] Bollerslev, T.(1990). Modelng he Coherence n Shor Run Nomnal Exchange Raes: A Mulvarae Generalzed ARCH Model. Revew of Economcs and Sascs 72, [7] Engle, R. (2002). Dynamc condonal correlaon A Smple Class of Mulvarae GARCH Models. Journal of Busness and Economc Sascs, 20, [8] Fraser, P., C. V. Hellar and D. M. Power (1994). An Emprcal Invesgaon of Convergence Among European Equy Markes, Appled Fnancal Economcs, 4, [9] Grubel, H.G. (1968). Inernaonally Dversfed Porfolos: Welfare Gans and Capal Flows, Amercan Economc Revew, 58, [10] Grubel, H. G., and K. Fadner. (1971). The Inerdependence of Inernaonal Equy Markes. Journal of Fnance, 26, [11] Gupa, R., 2006, Benefs of Dversfcaon no Emergng Equy Markes wh Changng Correlaons: An Ausralan Perspecve, Inernaonal Revew of Busness Research Papers, Vol.2, No. 4, December [12] Harvey, C.R. (2000).Drvers of Expeced Reurns n Inernaonal Markes, Emergng Markes Quarerly, 4, [13] Izan, H.Y., Jalleh, B.R. & Ong, L.L. (1991). Inernaonal Dversfcaon and Esmaon Rsk: Ausralan Evdence, Ausralan Journal of Managemen, 16, [14] Ibrahm, M. H. (2006). Fnancal Inegraon and Inernaonal Porfolo Dversfcaon US, Japan and ASEAN Equy Markes, Journal of Asa - Pacfc Busness, 7, [15] Jhendranahan, T. (2005). Wha Causes Correlaons of Equy Reurns o Change Over Tme? A Sudy of he U.S. and Russan Equy Markes. Invesmen Managemen and Fnancal Innovaons, 4, [16] Kargn, V, 2002, Value Invesng n Emergng Markes: Rsks and Benefs, Emergng Markes Revew, vol. 3, pp [17] Kroner, K.F., Ng, V.K. (1998). Modelng Asymmerc Comovemens of Asses Reurns. Revew of Fnancal Sudes 11, [18] Lessard, D. R. (1976). World, Counry, and Indusry Relaonshps n Equy Reurns: Implcaons for Rsk Reducon hrough Inernaonal Dversfcaon, Fnancal Analyss Journal, 32, p [19] Levy, H and M. Sarna (1970). Inernaonal Dversfcaon of Invesmen Porfolos, Amercan Economc Revew, 50, [20] L, K., Sarker, A., Wang, Z. (2003). Dversfcaon Benefs of Emergng Markes Subjec o Porfolo Consrans. Journal of Emprcal Fnance, 10, [21] Mchell, J., L. Wapnah and H.Y. Izan (1988). Inernaonal Dversfcaon: an Ausralan Perspecve, Deparmen of Accounng and Fnance Dscusson Paper No.88 12, Unversy of Wesern Ausrala.

11 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 136 [22] Schmukler, S. L. (2004). Fnancal Globalzaon: Gan and Pan for Developng Counres. Economc Revew, Federal Reserve Bank of Alana, 89, [23] Wason, J. and J.P. Dcknson (1981). Inernaonal Dversfcaon: an Ex-pos and Ex-ane Analyss of Possble Benefs, The Ausralan Journal of Managemen, 6, [24] Yang, S.Y. (2005). A DCC Analyss of Inernaonal Sock Marke Correlaons: The Role of Japan on he Four Asan Tgers. Appled Fnancal Economc Leers, 1, Table 1: Average Reurn Correlaons Beween Emergng Marke Indces and Ausralan Index From 11/19/95 o 8/31/05 Name Mean Sd. Dev. Mnmum Maxmum Argenna Brazl Mexco Peru Lan Amerca Chle Chna Inda Indonesa Malaysa Phlppnes Souh Korea Tawan Asa Czech Republc Hungary Poland Russa Easern Europe Israel Greece Turkey Ohers Average for All Emergng Markes

12 137 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) Table 2: Average Reurn Correlaons Beween Developed Marke Indces and Ausralan Index From 11/19/95 o 8/31/05 Name Mean Sd. Dev. Mnmum Maxmum Ausra Belgum Canada Denmark Fnland France Germany Hong Kong Ireland Japan Neherlands Norway Porugal Sngapore Span Sweden Swzerland Uned Kngdom Uned Saes Average for All Developed Markes Table 3: Ls of ADRs n he Porfolos Name Counry Indusry Exchanges Where DR s Lsng dae of raded DR AO Surgunefegaz Russa Ol & Gas Producers U.S., London, Germany 12/30/1996 AO Mosenergo Russa Elecrcy U.S., London, Germany 07/17/1997 Gazprom Russa Ol & Gas Producers U.S., London, Germany 10/21/1996 GUM (AO Torgovy Dom) Russa General Realers U.S., Germany 06/07/1996 Irkuskenergo Russa Elecrcy U.S., Germany 01/23/1997 Lukol Russa Ol & Gas Producers U.S., London, Germany 12/01/1995 Unfed Energy Sysems Russa Elecrcy U.S., London, Germany 05/12/1997 Tanef Russa Ol & Gas Producers U.S., London, Germany 03/06/96 Vmpel Communcaons Russa Moble Telecom. U.S., Germany 11/15/1996 OJSC Roselecom Russa Fxed Lne Telecom. U.S., London, Germany 09/01/1995 Seversky Tube Works Russa Indusral Meals U.S., Germany 02/01/1996 Bank BPH Poland Banks London, Germany 02/06/1995 Bank Mllennum Poland Banks Germany 07/28/1997 KGHM Polska Medz Poland Indusral Meals London, Germany 07/14/1997 Komercn Banka Czech Republc Banks U.S., London, Germany 06/29/05 Magyar Telecom Hungary Fxed Lne Telecom. U.S., London, Germany 11/19/1997 Mol Magyar Hungary Ol & Gas Producers London, Germany 11/27/1995 Mososal Expor Poland Consruc.& Maerals U.S., Germany 02/18/1997 Salexpor Poland Indusral Meals Germany 12/30/1994

13 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 138 Table 4: Descrpve Sascs of Weekly Reurns from 11/19/97 o 08/31/05 Name Mean Sd. dev. Skewness Kuross Jarque- Bera AO Surgunefegaz AO Mosenergo Gazprom GUM (AO Torgovy Dom) Irkuskenergo Lukol Unfed Energy Sysems Tanef Vmpel Communcaons OJSC Roselecom Seversky Tube Works Bank BPH Bank Mllennum KGHM Polska Medz Komercn Banka Magyar Telecom Mol Magyar Mososal Expor Salexpor Ausralan ndex Table 5: Average Reurn Correlaons Beween ADRs and Ausralan Index From 11/19/95 o 08/31/05 Name Mean Sd. Dev. Mnmum Maxmum AO Surgunefegaz AO Mosenergo Gazprom GUM (AO Torgovy Dom) Irkuskenergo Lukol Unfed Energy Sysems Tanef Vmpel Communcaons OJSC Roselecom Seversky Tube Works Bank BPH Bank Mllennum KGHM Polska Medz Komercn Banka Magyar Telecom Mol Magyar Mososal Expor Salexpor

14 139 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) Table 6: Descrpve Sascs of Ex-pos Reurns of Porfolos Name Mean Sd. dev. Skewness Kuross (Excess) Jarque- Bera All effcen porfolos One monh Three monhs Sx monhs Low rsk effcen porfolos One monh Three monhs Sx monhs Hgh rsk effcen porfolos One monh Three monhs Sx monhs Ausralan ndex One monh Three monhs Sx monhs Table 7: OLS Regresson Oupu for Ex-pos Reurns Agans Effcen Porfolo Dummy All porfolos One monh Three monhs Sx monhs Low rsk porfolos One monh Three monhs Sx monhs Hgh rsk porfolos One monh Three monhs Sx monhs * Sgnfcan a 1% ** Sgnfcan a 5% *** Sgnfcan a 10% α (-sa) β (-sa) Adj. R 2 (F-sa) Obs ( ) ( ) * ( ) * ( ) * ( ) * ( ) * ( ) * ( ) * ( ) * ( ) ( ) ** (4.4232) ** ( ) * ( ) * ( ) * ( ) * ( ) * ( ) * ( ) ( ) * (8.8245) * ( ) ( ) * ( ) * ( ) * ( ) * ( ) * 600

15 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) 140 Table 8: Weghs of Indvdual ADRs n Unresrced Porfolos All porfolos Low rsk porfolos Hgh rsk porfolos Mean Sd. dev. Mn.- Max. Mean Sd. dev. Mn.- Max. Mean Sd. dev. Mn.-Max. AO Surgunefegaz AO Mosenergo Gazprom GUM (AO Torgovy Dom) Irkuskenergo Lukol Unfed Energy Sysems Tanef Vmpel Communcaons OJSC Roselecom Seversky Tube Works Bank BPH Bank Mllennum KGHM Polska Medz Komercn Banka Magyar Telecom Mol Magyar Mososal Expor Salexpor Ausralan ndex

16 141 Inernaonal Research Journal of Fnance and Economcs - Issue 18 (2008) Table 9: OLS Regresson Oupu for Ex-pos Reurns Agans Effcen Porfolo Dummy: Wh Invesmens n ADRs Resrced o 20% of he Porfolo All porfolos One monh Three monhs Sx monhs Low rsk porfolos One monh Three monhs Sx monhs Hgh rsk porfolos One monh Three monhs Sx monhs * Sgnfcan a 1% ** Sgnfcan a 5% *** Sgnfcan a 10% α (-sa) β (-sa) Adj. R 2 (F-sa) Obs ( ) * ( ) (0.0599) ( ) * ( ) (1.7950) ( ) * ( ) ** (5.4483) ** ( ) ** ( ) (0.2982) ( ) * ( ) (2.5438) ( ) * ( ) ** (5.2564) ** ( ) ** ( ) (0.0469) ( ) * ( ) (0.0811) ( ) * ( ) (0.9655) 600