Is the Potential for International Diversification Disappearing? A Dynamic Copula Approach

Abstract

Quantifying the evolution of security co-movements is critical for asset pricing and portfolio allocation, hence we investigate patterns and trends in correlations and tail dependence for developed markets (DMs) and emerging markets (EMs). We use the standard DCC and DECO correlation models, and we also develop a nonstationary DECO model as well as a novel dynamic skewed t-copula to allow for dynamic and asymmetric tail dependence. We show that it is possible to characterize co-movements for many countries simultaneously. We …nd that correlations have signi…cantly trended upward for both DMs and EMs, but correlations between EMs are much lower than between DMs. Tail dependence has also increased but its level is still very low for EMs as compared to DMs. Thus, while the correlation patterns suggest that the diversi…cation potential of DMs has reduced drastically over time, our …ndings suggest that EMs o¤er signi…cant diversi…cation bene…ts, especially during large market moves. JEL Classi…cation: G12This section outlines the various models we use to capture dynamic dependence across equity markets. We describe how the dynamic conditional correlation model of Engle (2002) and Tse and Tsui (2002) can be implemented simultaneously on many assets. 5

Revisiting Fama–French factors' predictability with Bayesian modelling and copula‐based portfolio optimization

“…The latter is a proposed measure from Christoffersen et al (2012), and its description is provided in Appendix E. Table 8 is providing the M-V results. Except from the traditional measures of annualized return, Sharpe ratio, Sortino ratio, and MDD, we incorporate also the Return/CVaR ratio and the CDB.…”

“…Copula modelling plays a crucial role in the portfolio optimization research of past decades (Boubaker & Sghaier, 2013;Christoffersen, Errunza, Jacobs, & Langlois, 2012;Kakouris & Rustem, 2014;Patton, 2006;Sahamkhadam, Stephan, & Östermark, 2018). Recent studies on applications of copula-based models in finance show that the skewed t copula is able to incorporate the multivariate asymmetries in high-dimensional dependence modelling (Cerrato, Crosby, Kim, & Zhao, 2017;Christoffersen et al, 2012;Christoffersen & Langlois, 2013;Lucas, Schwaab, & Zhang, 2014). Recent studies on applications of copula-based models in finance show that the skewed t copula is able to incorporate the multivariate asymmetries in high-dimensional dependence modelling (Cerrato, Crosby, Kim, & Zhao, 2017;Christoffersen et al, 2012;Christoffersen & Langlois, 2013;Lucas, Schwaab, & Zhang, 2014).…”

“…We investigate the return predictability of Fama-French's (2015) five factors and explore their optimal portfolio allocation for factor investing over the period of 2000-2017. In order to evaluate the performance of the obtained tangency portfolios, several performance metrics are applied, such as annualized returns, Sharpe and Sortino ratios, maximum drawdown (MDD), return over CVaR ratio, and the conditional diversification benefits (CDB) of Christoffersen et al (2012). Firstly, we perform a one-step-ahead forecast for the first moment of each factor with a pool of linear and nonlinear models.…”

Country and Industry-Level Performance of NASDAQ-Listed European and Asia Pacific ADRs

“…Some previous studies, for example Jiang (1998), andSchaub (2004), show ADRs provide international diversification benefits to US investors. Other studies, such as Pukthuanthong and Roll (2009) and Christoffersen et al (2012), show these benefits have declined. A more recent study by Schaub and Brown (2015) finds ADR investing, versus investing in regional indexes, may still provide extra diversification benefits to US investors.…”

International Portfolio Diversification Benefits: The Relevance of Emerging Markets

“…Others studies highlighted a decrease of the benefits of emerging markets: for example, using a 16-year sample from 1988 to 2003, Garza-Gómez andMetghalchi (2006) found that ex-post benefits to U.S. investors who invested in this period in emerging markets are small. Moreover, Christoffersen et al (2012) showed that diversification benefits from adding emerging markets to a portfolio appear to be large compared to benefits of adding additional developed markets, even if they are getting smaller in an absolute sense. Thus, the pertinence of emerging markets in international portfolio diversification is an ongoing debate.…”