Time-Varying Market Integration and Expected Returns in Emerging Markets

47 Pages Posted: 15 Jan 2002

See all articles by Frans de Roon

Frans de Roon

Tilburg University - Department of Finance

Frank De Jong

Tilburg University - Department of Finance

Date Written: December 2001

Abstract

We use a simple model in which the expected returns in emerging markets depend on their systematic risk as measured by their beta relative to the world portfolio as well as on the level of integration in that market. The level of integration is a time-varying variable that depends on the market value of the assets that can be held by domestic investors only versus the market value of the assets that can be traded freely. Our empirical analysis for 30 emerging markets shows that there are strong effects of the level of integration or segmentation on the expected returns in emerging markets. The expected returns depend both on the level of segmentation of the emerging market itself and on the regional segmentation level. We also find that there is significant time-variation in the betas relative to the world portfolio because of the level of segmentation. For the composite index of the emerging markets we find an annual increase in beta of 0.09 due to decreased segmentation of the emerging markets in our sample period. In terms of expected returns the total effect on the composite index translates into an average decrease of 4.5% per annum. As predicted by our model, the noninvestable assets are more sensitive to the local and less to the regional level of segmentation than the investable assets. These conclusions do not change when using additional control variables. We do not find a clear pattern between volatility and segmentation, however.

Keywords: Emerging markets, asset pricing, market integration

JEL Classification: G12, G15, G18

Suggested Citation

de Roon, Frans A. and De Jong, Frank, Time-Varying Market Integration and Expected Returns in Emerging Markets (December 2001). CEPR Discussion Paper No. 3102. Available at SSRN: https://ssrn.com/abstract=296273

Frans A. De Roon

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 1 3466 8361/3025 (Phone)
+31 1 3466 2875 (Fax)

Frank De Jong (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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