Mahalanobis distance and Stutzer ratio modelling in emerging markets portfolios

This study examines the performance of multi-asset portfolios in global emerging markets, emphasizing their exposure to systemic risk and risk-adjusted returns. The analysis encompasses portfolios from regions such as Southeast Asia, the Middle East and Central Asia, Central and Eastern Europe, Africa, and Latin America. The research uses daily data, covering a 10 years period. Two advanced methodologies are applied in the portfolio construction – the Mahalanobis distance and the Stutzer ratio. The financial turbulence index constructed for the systemic risk measurement reveals a pronounced allocation bias toward a single asset, driven by its distinctive attributes. Interestingly, the asset with the highest weight in the portfolio originates from frontier markets, which are less integrated into the global financial system and thus more insulated from global economic shocks. The Stutzer ratio, through its calculation of the decay parameter theta, provides insights into whether an emerging market portfolio is characterized by high volatility and frequent market fluctuations or is more aligned with long-term investment strategies that emphasize stability and consistent performance. The results indicate that all emerging markets portfolios have higher Stutzer ratio than the developed portfolio, which indicates better risk-adjusted results. However, the theta parameter is mostly lower in the emerging markets portfolios, suggesting higher risk in these markets. The highest Sharpe ratio is found in the African countries portfolio, while the best portfolio, when using the more advanced Stutzer ratio, is with Latin American countries. This study provides insightful guidance for international investors exploring opportunities in emerging markets, focusing on systemic risk and evaluating returns through a risk-adjusted lens.