Separating the Wheat from the Chaff: Understanding Portfolio Returns in an Emerging Market

33 Pages Posted: 15 Oct 2012 Last revised: 23 Aug 2022

See all articles by Nicolas A. Eterovic

Nicolas A. Eterovic

Central Bank of Chile

Dalibor S. Eterovic

Columbia Business School; The Rohatyn Group

Date Written: October 14, 2012

Abstract

In this paper we apply Random Matrix Theory (RMT) to study daily returns correlations of 83 companies that are part of the Chilean stock market during the period 2000 to 2011. We find that using RMT to identify statistically significant correlations within our sample of stocks significantly improves the efficiency of a family of Markowitz Portfolios. Moreover, by using Vector Autoregressive analysis we identify global risk aversion as the main driver of the Chilean equity market returns followed in importance by shocks to the monthly rate of inflation and the country's monetary policy rate. By studying the effects of macroeconomic variables on the constructed portfolio returns we reach a better understanding of the true risks involved in an emerging market portfolio.

Keywords: Random Matrix Theory, Portfolio Optimization, Financial Markets and the Macroeconomy

JEL Classification: G10, G11, E44

Suggested Citation

Eterovic, Nicolas A. and Eterovic, Dalibor S., Separating the Wheat from the Chaff: Understanding Portfolio Returns in an Emerging Market (October 14, 2012). Emerging Markets Review, Vol. 16, No. 1, 2013, Available at SSRN: https://ssrn.com/abstract=2161646 or http://dx.doi.org/10.2139/ssrn.2161646

Nicolas A. Eterovic (Contact Author)

Central Bank of Chile ( email )

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Dalibor S. Eterovic

Columbia Business School ( email )

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