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International Asset Pricing and the Benefits from World Market Diversification

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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.

Suggested Citation

  • Nilsson, Birger, 2002. "International Asset Pricing and the Benefits from World Market Diversification," Working Papers 2002:1, Lund University, Department of Economics.
  • Handle: RePEc:hhs:lunewp:2002_001
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    File URL: http://project.nek.lu.se/publications/workpap/Papers/WP02_1.pdf
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    1. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
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    4. 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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    6. 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 1749-1778, December.
    7. repec:cup:etheor:v:11:y:1995:i:1:p:122-50 is not listed on IDEAS
    8. 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 507-538.
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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. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
    14. Adler, Michael & Dumas, Bernard, 1983. " International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-984, June.
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    16. Campbell R. Harvey & Akhtar Siddique, 2000. "Conditional Skewness in Asset Pricing Tests," Journal of Finance, American Finance Association, vol. 55(3), pages 1263-1295, June.
    17. 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 1507-1521, September.
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    Cited by:

    1. Mohamed El Hedi Arouri, 2005. "Intégration financière et diversification internationale des portefeuilles," Économie et Prévision, Programme National Persée, vol. 168(2), pages 115-132.
    2. Nicholas lawrence Samouilhan, 2007. "The Price Of Risk In The South African Equity Market," South African Journal of Economics, Economic Society of South Africa, vol. 75(3), pages 442-458, September.
    3. 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.
    4. repec:ebl:ecbull:v:6:y:2004:i:3:p:1-13 is not listed on IDEAS
    5. 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.
    6. 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.
    7. 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.

    More about this item

    Keywords

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

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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