Why Invest in Emerging Markets? The Role of Conditional Return Asymmetry

Abstract

We propose a quantile-based measure of conditional skewness, particularly suitable for handling recalcitrant emerging market returns. The skewness of international stock market returns varies significantly across countries over time, and persists at long horizons. In emerging markets, skewness is mostly positive and idiosyncratic, and significantly relates to a country's financial and trade openness and balance of payments. In an international portfolio setting, return asymmetry leads to sizeable certainty-equivalent gains and increases the weight on emerging countries to about 30%. Investing in emerging markets seems to be about expectations of a higher upside than downside, consistent with recent theories.

Keywords: return asymmetry, international equity markets, portfolio allocation, skewness

JEL Classification: G11, G15, C22