Financial Integration and International Portfolio

In this article, we extend the conditional ICAPM of De Santis and Gérard (1997,1998) using an asymmetric multivariate GARCH specification. The model is estimated, for the period March 1973-March 2003, simultaneously for 8 markets: the world market, 4 developed markets and 3 emerging markets. This approach, with double asymmetric effects, allows to the risk premia, betas and correlations to vary through time. Then, we investigate ex ante benefits from world market diversification. The evidence supports the financial integration hypothesis and suggests that investors from all countries could expect statistically significant benefits from international diversification but that gains are considerable larger for investors with smaller home markets. The impulse response functions from a VAR model comprised of the time-varying price of covariance risk series derived from GARCH model estimations show that movements in the price of risk belonging to developed markets are contagious. However, market turbulence on smaller stock markets may not be contagious internationally, which implies that investing abroad may offer larger protection against home market downturns for smaller- country investors.