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Inflation differentials and the diversification benefits of small cap equities in emerging markets for US investors

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  • Lorne N. Switzer

    (Concordia University)

  • Mashal Dhamani

    (Concordia University)

Abstract

The behavior of small caps in emerging markets has not received much attention in the academic literature. For international investors, this asset class is exposed to local and global market risk, default risk, political risks, and fiscal and monetary instability that give rise to inflationary pressures. This paper looks at the diversification benefits of small cap returns across emerging market countries, taking into account their exposure to inflation. The paper finds that for many of the countries with lower-than-average inflation, adding their small cap stocks to a US large-cap portfolio benchmark expands the mean variance frontier of the benchmark portfolio over the period 1999–2023. Diversification benefits of small cap stocks are rare for emerging countries with higher inflation, especially in the post GFC period.

Suggested Citation

  • Lorne N. Switzer & Mashal Dhamani, 2025. "Inflation differentials and the diversification benefits of small cap equities in emerging markets for US investors," Annals of Operations Research, Springer, vol. 346(1), pages 585-622, March.
    • Handle: RePEc:spr:annopr:v:346:y:2025:i:1:d:10.1007_s10479-024-06356-z
    DOI: 10.1007/s10479-024-06356-z
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    More about this item

    Keywords

    Small-cap equities; Emerging markets; Portfolio diversification;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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