Interim Evaluation of Emerging Market Investments: Time Aggregation of Utilities
56 Pages Posted: 5 Dec 2009 Last revised: 16 Dec 2010
Date Written: December 7, 2010
Comparing investments opportunities in the emerging and the developed markets is an important issue in the international portfolio management. However, it is well-established that the stock market returns are non-normal and have time-varying distributions. This creates a challenge in ranking alternative investment strategies especially in a dynamic setting. To this end, we propse a distribution-free test based on the spatial dominance approach introduced by Park (2007) which is more general than the stochastic dominance approach and allows us to compare the sum of utilities obtained from alternative investments accumulated over the planned investment horizon instead of at the terminal point of the investment. Applying the proposed test, we find that the investments in the emerging markets are indifferent from their developed market counterparts over all the investment horizons ranging from 3 month to 5 year, only if the currency risk is explicitly taken into account of. This suggests an integration between the two markets according to definition by Bekaert and Harvey (2003). We also find that the returns of emerging markets enominated in the local currency dominate those in the US dollar over 1- and 5-year investment horizons, implying that there is still an insufficient interaction between the equity prices and the foreign exchange rates in the emerging markets for the longer-term. As expected, the currency risk is found to be mostly irrelevant for the developed market investments.
Keywords: Stochastic and Spatial Dominance, Subsampling, Emerging and Developed Stock Markets Performance, Currency Risk
JEL Classification: C14, G15
Suggested Citation: Suggested Citation