# segmentation vs integration

hi guys, i am getting confused with the concept and math related to the subject. my understanding of segmented market would be a new emerging market like vietnam. it bears little similarity to other markets. therefore, it has very low beta risk but high idiosyncratic risk (i.e. if we regress this market against say msci world, we should expect high alpha term, but very low beta term with insignificant t-stats…). on other other hand, an integrated market such as u.s., should turn out to be a high beta market. however, looking at session 6 on the subject, the math coming out of ICAPM points me to an opposite direction. a fully segmented market scores the highest beta because the book claims that the correlation coefficient (rho) between the segmented market and the global market is ONE. isn’t this claim in conflict with the basics about diversification? appreciated if someone can help me out. thanks, (p78 in schwser book 2, p45 of cfai book 3)

rand0m Wrote: ------------------------------------------------------- > hi guys, > > i am getting confused with the concept and math > related to the subject. > > my understanding of segmented market would be a > new emerging market like vietnam. it bears little > similarity to other markets. therefore, it has > very low beta risk but high idiosyncratic risk > (i.e. if we regress this market against say msci > world, we should expect high alpha term, but very > low beta term with insignificant t-stats…). on > other other hand, an integrated market such as > u.s., should turn out to be a high beta market. > > however, looking at session 6 on the subject, the > math coming out of ICAPM points me to an opposite > direction. a fully segmented market scores the > highest beta because the book claims that the > correlation coefficient (rho) between the > segmented market and the global market is ONE. For a segmented market, the “global market” is just the domestic market (since full segmentation means the real global market like US mkt is out of reach). So domestic market is just the “global market” (which is just the domestic mkt) and of course p=1. - sticky

if what you said holds, then let’s look at formula for a segmented market’s ERP on p78 of schweser’s book 2; ERP(i) = sig(i)/sig(M) * ERP(M); given global market becomes domestic market as you suggested, then sig(i) = sig(M) so, ERP(i) = ERP(M). i.e. beta = 1 (clearly schweser didn’t make such a stretch in its example, i.e. it didn’t treat domestic as global under the situation of segmentation) =============================================================== my view is, as you said, for segmented market, “global market is out of reach”, therefore, in the context of ICAPM, correlation between the two should be zero (rather than one). as a result, the beta of a segmented market to the global one is zero (i.e. a position in vietnam has little beta exposure to the global market). with correlation being zero, the theory of diversafication and efficient market flies since adding it to my portfolio would reduce risk and boost returns …