According to page 377 of “Fixed Income and Equity Portfolio Management” a paragraph says: “The model suggests that expected returns (cost of capital) should decrease. The reason is that the volatility of emerging market returns is much higher than their covariances with world market returns. Holding the variances and covariances constant, this implies that prices should rise (expected returns decrease) when a market moves from a segmented to an integrated state.” I don’t see why expected returns should decease if co-variance and variance remains constant. Can anyone explain this in simple English?
P= D / r-g , price rising resulted from or results expected return decrease, Integration means covariance with emerging market & other part of the world not decreasing. I think the R is decreasing because one doesn’t expect there is no diversification effect as the covariance is not expected to decrease (= constant, because of integration).
The reason returns are expected to decline is because as markets become integrated correlation between markets is set to increase and emerging market variance is expected to decrease. Consequently returns should decrease due to lower required returns and decreased benefits accruing to diversification. Secondly, as emerging economies develop the incremental return to increases to capital decline and approach that of developed economies.
bodhisattva Wrote: ------------------------------------------------------- > The reason returns are expected to decline is > because as markets become integrated correlation > between markets is set to increase and emerging > market variance is expected to decrease. > Consequently returns should decrease due to lower > required returns and decreased benefits accruing > to diversification. > > Secondly, as emerging economies develop the > incremental return to increases to capital decline > and approach that of developed economies. Didn’t read the part about variance remaining constant, either way as markets become integrated, correlation increases ex R declines
Nope, the paragraph I pasted on the first post isn’t answered. I’ll just memorised it and move on… like many other texts which don’t make sense.