Working Paper: NBER ID: w8612
Authors: William N. Goetzmann; Lingfeng Li; K. Geert Rouwenhorst
Abstract: In this paper we examine the correlation structure of the major world equity markets over 150 years. We find that correlations vary considerably through time and are highest during periods of economic and financial integration such as the late 19th and 20th centuries. Our analysis suggests that the diversification benefits to global investing are not constant, and that they are currently low compared to the rest of capital market history. We decompose the diversification benefits into two parts: a component that is due to variation in the average correlation across markets, and a component that is due to the variation in the investment opportunity set. There are periods, like the last two decades, in which the opportunity set expands dramatically, and the benefits to diversification are driven primarily by the existence of marginal markets. For other periods, such as the two decades following World War II, risk reduction is due to low correlations among the major national markets. From this, we infer that periods of globalization have both benefits and drawbacks for international investors. They expand the opportunity set, but diversification relies increasingly on investment in emerging markets.
Keywords: No keywords provided
JEL Codes: F3; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| globalization (F60) | correlation structures (C10) |
| high capital flow (F32) | high correlations among markets (G15) |
| periods of poor market performance (E32) | high correlations (C10) |
| variation in average correlation (C10) | diversification benefits (G11) |
| investment opportunity set (G11) | diversification benefits (G11) |
| globalization (F60) | investment opportunity set (G11) |
| historical periods of high capital flow (F32) | diversification benefits (G11) |
| market downturns (G10) | increased correlations (C10) |