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The plausibility of risk estimates and implied costs to international equity investment

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  • De Moor, Lieven

    (Katholieke Universiteit Leuven, Belgium
    Hogeschool-Universiteit Brussel (HUB), Belgium)

  • Sercu, Piet

    (Katholieke Universiteit Leuven, Belgium)

  • Vanpée, Rosanne

    (Katholieke Universiteit Leuven, Belgium)

Abstract

In this paper we reconsider the estimated deadweight costs for the emerging countries implied by the mean-variance portfolio model developed by Cooper and Kaplanis (1994) and general- ized by Sercu and Vanp¶ee (2007). We show both theoretically and empirically that estimated implicit investment costs are mostly driven by estimated risk if home bias is strong, which is particularly the case for emerging markets. For OECD countries, risk is stable and relatively easy to estimate, but for emerging markets ex post risk may be very different from ex ante risk and changes substantially over time. The required expected returns that go with the naïve risk estimates and are at the basis of the high implied costs of international equity investments defy credibility, whether a priori or empirically. We show that more sophisticated volatility estimates based on a time-varying model a la Bekaert and Harvey (1997) lead to implicit investment costs that are far more credible.

Suggested Citation

  • De Moor, Lieven & Sercu, Piet & Vanpée, Rosanne, 2007. "The plausibility of risk estimates and implied costs to international equity investment," Working Papers 2007/34, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
    • Handle: RePEc:hub:wpecon:200734
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    File URL: http://lirias.hubrussel.be/handle/123456789/2201
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    1. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    2. Mishra, Anil V., 2016. "Foreign bias in Australian-domiciled mutual fund holdings," Pacific-Basin Finance Journal, Elsevier, vol. 39(C), pages 101-123.
    3. Heeho Kim, 2017. "The Spatial Impact of Cultural Distances on Home Bias across Asian Emerging Markets," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 45(1), pages 81-101, March.
    4. Nicolas Coeurdacier & Hélène Rey, 2010. "Home bias in open economy financial macroeconomics," SciencePo Working papers hal-01069440, HAL.
    5. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," Journal of Economic Literature, American Economic Association, vol. 51(1), pages 63-115, March.
    6. Anil V. Mishra, 2017. "Foreign bias in Australia's international equity holdings," Review of Financial Economics, John Wiley & Sons, vol. 33(1), pages 41-54, April.
    7. repec:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    8. Kim, Heeho & Cho, Seong-Hoon & Kim, Yongku, 2015. "Home bias, risk differential, and cultural spatial spillover effects," Journal of International Money and Finance, Elsevier, vol. 51(C), pages 114-136.
    9. Mishra, Anil V. & Ratti, Ronald A., 2013. "Home bias and cross border taxation," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 169-193.
    10. repec:spo:wpmain:info:hdl:2441/1shj1p7td8e0r5c9fcsnk8a91 is not listed on IDEAS
    11. Mishra, Anil V., 2015. "Measures of equity home bias puzzle," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 293-312.

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