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Change In Volatility Regimes And Diversification In Emerging Stock Markets

Listed author(s):
  • Ming-yuan leon Li

A multivariate Markov-switching ARCH (MVSWARCH) model in which variance/correlations for stock returns is controlled by a state-varying mechanism is introduced and used to design a state-varying US-EM (emerging market) portfolio establishment strategy. Additionally, a conventional random-variance framework, the MVGARCH (multivariate GARCH) model, in which a time-varying technique is involved is employed and subjected to comparative analysis. The empirical results are consistent with the following notions: First, as being consistent with a study conducted by Ramchand and Susmel , the US-EM market correlations are higher when the US market is more volatile. However, this study further indicates that the US-EM market correlations increase relatively more when both the US and EM markets simultaneously experience a high variance condition. Moreover, the situation of both the US and EM stock markets at a high volatility state is associated with a minimum risk reduction benefit and a maximum cross-market correlation. Second, the state-varying portfolio loadings established by the MVSWARCH model could effectively enhance asset allocation effectiveness; however, this benefit arises more as a result of risk reduction than an increase in mean returns. Copyright (c) 2009 The Authors. Journal compilation (c) 2009 Economic Society of South Africa.

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Article provided by Economic Society of South Africa in its journal South African Journal of Economics.

Volume (Year): 77 (2009)
Issue (Month): 1 (03)
Pages: 59-80

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Handle: RePEc:bla:sajeco:v:77:y:2009:i:1:p:59-80
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