| Lam3rok | Дата: Воскресенье, 03.11.2013, 21:07 | Сообщение # 1 |
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| OPTIMAL INTERNATIONAL DIVERSIFICATION WITH CONSTRAINTS
Krytsyna T.O., student of master degree Scientific adviser: Moiseenko K.E., senior teacher
Donetsk State University of Management
Donetsk, Ukraine
Research question. The global processes imply the necessity introduc-tion of constraints to various activities related to the financial markets and global markets as a whole. So the benefits of the investors operating at fi-nancial markets under the circumstances of specified limitation are being questioned. This paper presents a brief outlook at international diversifica-tion with constraints opportunities for global investors in long- and short-time perspectives.
The aim of this research is to empirically investigate the potential benefits of international diversification for the investors with various in-vestment constraints from both long-term and time-rolling perspectives.
Summary of the research results. An important issue in international economics concerns the size of benefits from diversifying over securities in foreign countries, especially securities in emerging markets. Currently the pace of global development shifts towards emerging economies, in-cluding the development of financial markets and financial operations. In theory, if foreign securities do not perfectly correlate with domestic securi-ties, domestic investors gain from international diversification and accrue extra profits from transaction. However, the magnitude of the diversifica-tion benefits in general depends on various portfolio constraints, which are introduced due to the multiple factors affecting the financial markets and securities trade. For instance, such constraints as investors’ ability to take short positions might be introduced at foreign markets. Given the existence of derivative securities on stock market indices in developed countries, it is
often feasible for institutional investors to take short positions on devel-oped markets, but still the diversification in terms of expansion over those markets might be quite beneficial.
In fact, existing literature has highlighted two main channels through which financial markets can co-move. The first one, put forward by the in-ternational economics literature, is the terms of trade channel. A shock to a country affects its terms of trade and therefore affects stock prices in the countries it is trading with. The second one, emphasized in the internation-al asset pricing literature, is the common discount factor channel [1]. When investors are diversified internationally and financial markets are frictionless, the cash flows of all assets are discounted with the same state prices (common discount factor). Changes in state prices then cause asset prices to co-move even if their cash flows are uncorrelated. However, nei-ther of these channels can account for the full extent of international co-movement in the data. Direct measures of the terms of trade channel fail to explain contagion during crises.
Anyway, the vast majority of researches have investigated and docu-mented the gains from international diversification for the investors, while the gains from operations at foreign markets may not exceed the level of domestic performance. Alternatively, Eun and Resnik have proved that in-ternational portfolio diversification outperform purely domestic portfolios even when taking exchange risk into account. However, as illustrated by Cooper and Kaplanis and French and Porterba, individuals invest signifi-cantly much more in their respective domestic financial markets. This phenomenon is the so-called "home bias" [2].
Taking into consideration all mentioned above, the perspective of suc-cessful and diversified performance at foreign markets is a tempting op-portunity to increase the amount of profits accrued by the investor and to expand the range of his activities. This paper provides a consistent qualita-tive framework to determine the optimal international portfolio for foreign
and domestic investments when no arbitrage is allowed but when the in-vestor faces specific constraints. The assumption for the domestic market used in this paper is as follows: all domestic-denominated assets discount-ed by a domestic money market account are martingales under a risk-neutral probability. Following the classical theories, the stochastic volatili-ties can be considered in the dynamics of both domestic and foreign rates and the foreign term structure can be endogenously determined – which makes it possible to use this data in terms of risk-determination and degree of profit rates calculation. In practice, it is necessary to determine the "vol-atility" matrix and to estimate the risk premium associated to price func-tional, that is the risk-neutral probability of interest. Obviously, it depends on the dynamics of the exchange rates and so takes into account the change risk. Although the risks can not be precisely assessed, the model for their trend and future volatility might be modeled. Then, the optimal portfolio is deduced from the specific constraints by using an auxiliary un-constrained problem where all drifts are modified by the addition of a La-grangian process. This process itself is the solution of a particular minimi-zation problem which can be explicitly solved in some cases or relatively easily computed by numerical methods. Additionally, from the observa-tions of the optimal portfolio, partial information about constraints can be deduced [2]. This would be of particular interest to examine how the con-straints of the investor can change according to variations of factors such as macroeconomic or financial variables or, within our framework, accord-ing to the level of specific costs such as transaction and information costs.
Conclusions. Having presented an overview of diversification issues we may state that under the circumstances of introduction of reasonable constraints, the entire process of diversification will be successful and profit-accelerating. Furthermore, such diversification would be quite bene-ficial when it comes to financial markets and financial transactions at emerging markets. While the addition of portfolio bounds makes asset al-
location more feasible, our findings suggest that adding short-selling and over-weighting constraints reduce but do not completely eliminate the di-versification benefits of international investment. The over-time analyses show that diversifying portfolios internationally is still beneficial even though financial markets are becoming more integrated. The significant time variation in optimal asset allocation implies the necessity for the fund manager to rebalance international portfolio dynamically, including geo-graphical diversification.
References
1. The role of portfolio constraints in the international propagation of stocks. [Electronic resource] // Mode of access: http://faculty.london.edu/apavlova/Constraints.pdf.
2. Optimal geographic diversification with constraints. [Electronic re-source] // Mode of access: http://www.questia.com/library....etails.
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