#11-20
Is the Potential for International Diversfication Disappearing?
Peter Christoffersen, Vihang Errunza, Kris Jacobs and Xisong Jin, November 2010
Abstract: Quantifying the evolution of security co-movements is critical for asset pricing and portfolio
allocation, and so we investigate patterns and trends in correlations and tail dependence over
time using weekly returns for developed markets (DMs) and emerging markets (EMs) during
the period 1973-2009. We use the DECO, DCC, and BEKK correlation models, and develop
a novel dynamic t-copula to allow for dynamic tail dependence. We show that it is possible to
characterize co-movements for many countries simultaneously. Correlations have significantly
trended upward for both DMs and EMs, but correlations between EMs are lower than between
DMs. Further, our evidence clearly contradicts the decoupling hypothesis. The tail dependence
has also increased for both EMs and DMs, but its level is still very low for EMs as compared to
DMs. Thus, while our correlation analysis suggests that the diversfication potential of EMs
has reduced over time, the tail dependence analysis suggests that EMs offer diversfication
benefitts during large market moves.
Keywords: asset pricing, asset allocation, dynamic conditional correlation (DCC), dynamic equicorrelation (DECO), dynamic copula.
JEL classifications: G12
