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International Portfolio Diversification
International Portfolio Diversification
DIVERSIFICATION :
Case of international portfolio diversification was established in
1960s and 1970s (US and other markets become increasingly
active in foreign markets)
Integration of global markets due to liberalization and deregulation
in the money and capital markets of developed and developing
countries.
In recent years due to currency crisis and issues of
macroeconomics investors like US are moving towards emerging
markets of Central Europe.
Central European countries are endeavouring to line up their
markets economies and institutions with Western European
countries in hope of joining EU and EMU.
Purpose of this presentation is to find the diversification of US
investors in three most important markets of Central Europe i.e
Czech, Poland, Hungary using methodology of cointegration.
LITRETURE REVIEW
Advantages from the international diversification emanating from
the low correlation b/w developed and emerging stock markets
have been demonstrated in many studies using short term horizons
like Wheatly(1988), Meric and Meric(1989), Bailey and stulz(1990).
Kasa(1992) points out the benefits for investors with long term
investment horizons if markets are trending together leading to use
cointegration techniques. Kasa(1992) and Arshanpalli and
Doukas(1993) found bivariate cointegration of US investors with
emerging markets. However Byers and Peel(1993) and
Kanas(1998) suggest that there is no such linkage.
w.r.t emerging capital markets, Defusco(1996) report that the the
US market is not cointegrated with thirteen emerging markets of
three geographical regions(Pacific Basin, Mediterranean and Latin
America)
Felix(1998) find no long run comovement b/w US and many
developing markets.
MARKET CHARECTERISTICS
Fall of Communism in Central Europe lead to reopening of the
stock exchanges BSE(Budapest Stock Exchange),WSE(Warsaw
Stock Exchange) and PSE(Prague Stock Exchange) which have
been closed during post war
WSE has been the largest in terms of capitalization followed by
BSE and PSE.
BSE lagged in terms of turnover ratios and trading values but has
taken over the others.
WSE opened trading in shares in 5 firms only, which had
been privatized at the end of 1990.
In WSE as well as BSE the number of listed firms has grown
slowly, as a result of a gradual approach to privatization.
PSE opened with large number of private firms listed through
in 1996.
METHODOLOGY
Cointegration analysis is used to examine the issue of likely
benefits of diversification into Central European equity markets
by US.
Cointegration tests allow us to determine whether stock prices
of different national markets move together over the long run,
while allowing for the possibility of short-run divergence.
First step is to test each index series for the presence of unit
roots, which would show whether the series are non-stationary.
Augumented Dickey Fuller (ADF) is used, this test assumes
that the errors are statistically independent and have a
constant variance.
Phillips and Perron developed a generalization of the Dickey
Fuller test, which is also applied here.
• Engle Granger methodology 1987 and the Johansen 1988
procedure are the two basic approaches used.