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International Asset Pricing and the Benefits from World Market Diversification

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Author Info

  • Nilsson, Birger

    ()
    (Department of Economics, Lund University)

Abstract

This paper extends previous tests of the conditional CAPM using different asymmetric and non-diagonal multivariate GARCH-M specifications for eight large national markets and the world market simultaneously. To solve the well-known problems associated with the likelihood functions of multivariate GARCH models, maximization is performed using simulated annealing, a Markov Chain Monte Carlo stochastic optimization method. We find that a model with double asymmetric effects and a time-varying price of world covariance risk supports all tested asset-pricing restrictions and that the previously often employed symmetric diagonal specification is overwhelmingly rejected. The evidence suggests that investors from all countries could expect statistically significant benefits from international diversification but that gains are considerable larger for investors with smaller home markets than for US and Japanese investors.

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File URL: http://project.nek.lu.se/publications/workpap/Papers/WP02_1.pdf
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Bibliographic Info

Paper provided by Lund University, Department of Economics in its series Working Papers with number 2002:1.

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Length: 44 pages
Date of creation: 01 Feb 2002
Date of revision:
Handle: RePEc:hhs:lunewp:2002_001

Contact details of provider:
Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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Related research

Keywords: international asset pricing; portfolio diversification; asymmetric and non-diagonal multivariate GARCH; simulated annealing;

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References

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  1. Engle, Robert F & Ng, Victor K, 1993. " Measuring and Testing the Impact of News on Volatility," Journal of Finance, American Finance Association, vol. 48(5), pages 1749-78, December.
  2. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-84, June.
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  4. Goffe, William L. & Ferrier, Gary D. & Rogers, John, 1994. "Global optimization of statistical functions with simulated annealing," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 65-99.
  5. Ng, Lilian, 1991. " Tests of the CAPM with Time-Varying Covariances: A Multivariate GARCH Approach," Journal of Finance, American Finance Association, vol. 46(4), pages 1507-21, September.
  6. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, 06.
  7. Chan, K. C. & Karolyi, G. Andrew & Stulz, ReneM., 1992. "Global financial markets and the risk premium on U.S. equity," Journal of Financial Economics, Elsevier, vol. 32(2), pages 137-167, October.
  8. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, vol. 60(4), pages 668-75, September.
  9. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
  10. Lin, Wen-Ling & Engle, Robert F & Ito, Takatoshi, 1994. "Do Bulls and Bears Move across Borders? International Transmission of Stock Returns and Volatility," Review of Financial Studies, Society for Financial Studies, vol. 7(3), pages 507-38.
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  12. Chang, Eric & Eun, Cheol S. & Kolodny, Richard, 1995. "International diversification through closed-end country funds," Journal of Banking & Finance, Elsevier, vol. 19(7), pages 1237-1263, October.
  13. John M. Griffin & G. Andrew Karolyi, . "Another Look at the Role of the Industrial Structure of Markets for International Diversification Strategies," Research in Financial Economics 9608, Ohio State University.
  14. Francesca Carrieri, 2001. "The Effects of Liberalisation on Market and Currency Risk in the European Union," European Financial Management, European Financial Management Association, vol. 7(2), pages 259-290.
  15. repec:cup:etheor:v:11:y:1995:i:1:p:122-50 is not listed on IDEAS
  16. Young-Hye Cho & Robert F. Engle, 1999. "Time-Varying Betas and Asymmetric Effect of News: Empirical Analysis of Blue Chip Stocks," NBER Working Papers 7330, National Bureau of Economic Research, Inc.
  17. De Santis, Giorgio & Gerard, Bruno, 1998. "How big is the premium for currency risk?," Journal of Financial Economics, Elsevier, vol. 49(3), pages 375-412, September.
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Citations

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Cited by:
  1. AROURI Mohamed El Hedi, 2004. "The Impact of Increasing Stock Market Integration on Expected Gains from International Portfolio Diversification: Evidence from a Multivariate Approach with Time Varying Risk," Economics Bulletin, AccessEcon, vol. 6(3), pages 1-13.
  2. Sébastien WÄLTI, 2003. "Testing for Contagion in International Financial Markets: Which Way to Go?," FAME Research Paper Series rp92, International Center for Financial Asset Management and Engineering.
  3. Jaroslava Hlouskova & Kurt Schmidheiny & Martin Wagner, 2002. "Multistep Predictions from Multivariate ARMA-GARCH: Models and their Value for Portfolio Management," Diskussionsschriften dp0212, Universitaet Bern, Departement Volkswirtschaft.
  4. Hlouskova, Jaroslava & Schmidheiny, Kurt & Wagner, Martin, 2009. "Multistep predictions for multivariate GARCH models: Closed form solution and the value for portfolio management," Journal of Empirical Finance, Elsevier, vol. 16(2), pages 330-336, March.
  5. repec:ebl:ecbull:v:6:y:2004:i:3:p:1-13 is not listed on IDEAS

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