The Relative Importance of Global, Country and Sector Risks

Abstract

We construct a state-dependent trivariate GARCH-M model to extract state-dependent risk-aversion coefficients around the 1997-1999 financial meltdown. These coefficients are further used to decompose sector risk into global (systematic), country-specific (diversifiable through global country allocation) and sector-specific (diversifiable through domestic sector allocation) risk measures. Our investigation shows that diversification benefits of sector-based allocation have increased as a result of the Asian meltdown. Nevertheless, the importance of country factors persists. Finally, we find that sector-specific effects are as important as country effects and increase slightly over the period of study.

Keywords: GARCH-M, Risk Decomposition, Asian Meltdown

JEL Classification: G10, G14, G15, F21