The Best of Both Worlds: Accessing Emerging Economies via Developed Markets

Abstract

A growing body of evidence suggests that the benefits of international diversification via developed markets have dramatically declined. While emerging markets still offer diversification opportunities, their public equity indices capture only a fraction of economic activity of emerging countries. We propose a diversification approach that exploits the global connectedness of developed countries to gain exposure to emerging countries' overall economies rather than their shallow equity markets. In doing so, we demonstrate that developed markets still offer substantial diversification benefits beyond those available through equity indices. Our results suggest that relying on equity indices to assess diversification benefits understates diversification gains.

Keywords: International diversification, emerging markets, developed markets, diversification benefits, performance, export links, market integration

JEL Classification: G11, G12, G15, F30