Abstract:

We test if diversification benefits exist for a US investor conditional on periods of low domestic returns, high domestic volatility, or periods of international financial crises. When diversification benefits are needed, parameter stability tests indicate that developed and emerging market equities exhibit lower mean returns with higher volatility. Spanning tests indicate that developed, relative to emerging, market equities offer the greatest diversification benefits to domestic US investors. However, these diversification benefits are dampened when they are needed, especially in the case of high domestic market volatility. This analysis also provides insight into the dynamics of both developed, and emerging, capital markets, conditional on behavior of the US market. The analysis indicates emerging markets exhibit poor performance concurrent with poor US market performance.