For more information
Call 1-800-351-0222
Call 1-800-351-0222
GLOBAL ASSET ALLOCATION.
Term Paper ID:28691
Essay Subject:
Discusses investment practices & issues incl. Global diversification, management style, currency hedging, risks & rewards, equity markets/correlations. Country & industry effects. GAA models.... More...
19 Pages / 4275 Words
14 sources, 24 Citations,
APA Format
$76.00
More Papers on This Topic
Paper Abstract:
Discusses investment practices & issues incl. Global diversification, management style, currency hedging, risks & rewards, equity markets/correlations. Country & industry effects. GAA models.
Paper Introduction:
Introduction
Global asset allocation has gained importance as people realize the diversification effect of international investments and the extent of international equity market inefficiencies. Countries differ significantly in their cultural, economic, and financial characteristics. Investment practices vary a great deal in terms of underlying philosophies and processes. The objective of global asset allocation is to assess the challenges and opportunities presented by the global market and provide a conceptual framework for investment management.
Risk and Reward for Investors
Traditional approaches to investing hold that greater risk carries with it greater returns, and that less risky investments offer lower returns as well as stability. Successful investors, therefore, find ways to bal
Text of the Paper:
The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper.
Risk and Reward for Investors Traditional approaches to investing hold that greater risk carrieswith it greater returns, and that less risky investments offer lowerreturns as well as stability. Styles may be actively managed by either portfolio managersor managers of fund managers. 16). International Diversification International markets usually have low correlations one to the otherand thus provide substantial diversification for investors since a downturnin one market does not necessarily result in a downturn throughout theportfolio ("Specialized," 1998, p. S131). Therefore, currency exposure proves to be a gooddiversification tool, and completely hedging away currency risk will not beoptimal. For example,according to some indices, value has outperformed growth in the UnitedStates in only 12 of the 24 years from 1975 through 1998. S1 7). In this way, a company which has a given amount in a bank in a foreigncountry and who maintains that balance over the course of the year may findthat due to exchange rates, the balance falls when translated into dollars. The benefit of global diversification is greatestwhen investors have longer investment horizons, as correlations tend to belower for multiyear holding periods. As realizedcorrelations fluctuate widely over time, and much of realized correlationis due to fortuity rather than geocultural, economic, and financialreasons, any elaborate model runs the risk of overfitting and chasing arandom target. S97-S1 9. W. A forward hedge is essentially a derivative contract with thecurrencies in question serving as the measure of the contract. In general, currency volatilities are approximately halfof foreign equity market volatilities from an American investor'sperspective. Efficiency in currency futures markets.Economic Record, 68, pp. (1997). Anomalies related to uncovered interest rate parityand the trending behavior of currencies, together with investors' superiorskill in forecasting currencies, can further move one's strategy towardactive hedging, depending on investor risk tolerance and skills. A credit or money market hedge involves borrowing against the amountin question in order to make a profit over the time period in question. Style management is an integral part of global investment. If the value premium isdue to its inherent risk, value stocks should be expected to outperformgrowth stocks over the long-run. Hemmerick, S. These include issues related to global diversification,investment horizon, country and industry effects, style management, andcurrency hedging. Furthermore, if growth has become overpriced, thefuture value effect may be even stronger than in the past. According to one analyst who has studied the impact of the EMU on theEuropean stock markets, despite fiscal and monetary coordination in manyEuropean states since 1992, country effects show no tendency to disappearfrom European markets. Even so, industry effects still account for only2 to 3 percent of the variation in stock returns that can be accountedfor by both country and industry (Heston & Rouwenhorst, 1994, p. For 1994-1998,according to Salomon Smith Barney style indexes, growth outperformed valueby 7. G. There are exceptions for some Europeancountries, where correlations tend to return to very high levels for four-and five-year holding periods. When these pricing errors are corrected, distressed (value)stocks tend to outperform growth stocks. The value-growth dichotomy is a manifestation of both market mistakes and inherentdifferences between value and growth stocks. Journal of Portfolio Management, 2 , pp. Journal of Finance, 49, pp. In either case, investors should be aware that there are inherentrisks with value or growth strategies, and risk control must considereconomic growth, credit cycles, yield curve movements, inflation, andoverall market performance. Specializedfinancial applications. (1995, February). Therefore, deriving the properstrategic allocation mix and performance benchmarks is extremely important. While these theoretical analyses may be difficult to accept, they arenevertheless intuitively appealing. One surprising observation is that growth stocks have outperformedvalue stocks by a large margin in the most recent past. For example, the energy industry may have become more globallyintegrated as energies have become more like standard commodities, andfutures markets bring in more pricing efficiency. Global Style Management Many researchers find that value stocks produce higher returns thangrowth stocks in the American stock market. Financial Analysts Journal, pp. (1999, September2 ). The averageoutperformance based on monthly returns is .5 percent per year, with a t-statistic of .34 (Fama & French, 1997, p. F., & French, K. SSB explores approaches to global asset allocation. 1 ). Thus investorsmight have assets in several different industries, and in bonds as well asstocks, in options as well as outright purchases, and achieve a risk-rewardbalance in this manner. 1549). Second, the world economies have become moreintegrated over time, which means that world equity markets are moreintertwined. For example, an American multinational might agree to sell $1 millionin goods to an importer in Japan and the current exchange rate might be 1 yen to the dollar. It is fair to say that country selection is still moreimportant but industry selection is likely to become increasinglyimportant. At the same time, growth outperformedvalue in eleven out of twenty-two countries. This inconclusivenessis a manifestation of the broad spectrum of stocks included in the indicesand the narrow definition of value and growth. Over time, an investor's appetitefor risk is likely to change, with younger investors being more willing toaccept risk (generally speaking) and older investors being less risktolerant. Economic integration and country allocation inEurope. The unhedged strategy may not be advisable either. (199 ). 6). These analysts sometimesmaintain that value stocks may be riskier and thus require a returnpremium. Later studies find that value stocks outperform growth stocks in mostinternational markets as well, both absolutely and after adjustment forrisk. This can prompt fears among managers that stockholders and othersinterested in the company's performance may conclude that management is notdoing its job because of the loss when the loss is not the result ofmanagement activities (necessarily) but instead is due to fluctuations inthe exchange rate. S1 5-S116. For traders with veryshort horizons, however, this long-term approach may not be accurate ortimely; advanced econometric modeling of high frequency returns may be moreindicative of subsequent market co-movements. For example, the correlation betweenthe American and Canadian equity markets according to one index for 1975-1998 is .75 for one-month holding periods, .79 for three-month holdingperiods, .65 for one-year holding periods, and .42 for five-year holdingperiods. The global perspective. Economic Record, 68, pp. Heston, S. (1992, June). Thetransaction (purchase or sale) carries a risk that the currency value willchange; hence the term transaction risk. Countries differ significantlyin their cultural, economic, and financial characteristics. It seems thatthe style cross-correlations are low for most countries. S131). An examplecan be provided by a multinational company which sells goods to a foreignimporter. The Germanbanking industry concentrates heavily on commercial banking. For example, the American banking industry has moreinvestment banking and brokerage business than other countries. Rewards available to currency futuresspeculators. 18). Preliminary studies bySalomon Smith Barney and others tend to confirm this (Griffin, 1998, p.63). In addition, those correlationswhich are realized may well fluctuate widely over time. An importer in a country whose currency is expected to depreciate interms of the currency of the supplier is motivated to purchase the foreigncurrency as soon as possible in order to get the most favorable rate ifpayment is due in the currency of the exporter. (1998, January). As consumption is also global, thepurchasing power of any single currency is subject to unfavorablemovements. The success of global asset allocationlies in well-founded philosophies and processes, of which performance isonly the by-product in the long term. 3-27. However, it is not realistic of companies to expect thatexchange rates will not change, although criticism that losses or gainsshould be noted only when actually realized is a legitimate concern. W. As was the case prior to the treaty, countryeffects in stock returns continue to dominate industry effects.Nevertheless, active investors may seek opportunities both across countriesand across industries depending on their relative industry and countryskills. Successful investors, therefore, find waysto balance their risk and reward based in part on their personal investmentgoals, their own level of risk-taking, as well as their position in themarket and their financial situation. One of these includesback to back loans, where two multinational companies based in twodifferent countries have subsidiaries located in the other country. 1975-1999. Does industrialstructure explain the benefits of industrial diversification? Quarterly Review of Economics andBusiness, 3 , pp. When the loan comes due, it will be paid forwith the yen due from the importer, and the proceeds from the investmentscan be used to pay interest. Transaction Risk Transaction risks usually involve a receivable or payable denominatedin a foreign currency, and commonly arise from a transaction such as apurchase from a foreign supplier or a sale to a foreign customer. The volatilities of currenciescan be very high at times and greatly affect the overall fund volatilitiesand performances. The importer agrees to pay the multinational 1 million yen in 18 days. Journalof Finance, 53, pp. They can use back-to-back loans to fundsubsidiaries, or they may choose one of the international capital markets,including New York, London, Zurich, or the Cayman Islands, among others.Each market offers particular advantages and disadvantages at any point intime, and the price and cost associated with one market vary widely bothwith other markets and over time. Thusan American multinational might have a subsidiary in the United Kingdom,and an English multinational might have a subsidiary in the United States.With back to back loans, each multinational loans an agreed upon figure, inthe home currency, to the subsidiary of the other multinational at thecurrent exchange rate. To protect itself from this risk,companies can engage in various types of hedging, including a forwardhedge, a credit or money market hedge, or the company may choose toaccelerate or delay payment. These realized correlations are thecombined effect of fundamental linkages and time series fluctuations, andsuch models predict that correlations steadily increase over time (Jeon &von Furstenberg, 199 , p. A similarflight to quality phenomenon in international markets reduces the benefitof international diversification when investors need it the most(Hemmerick, 1997, p. Lakonishok, J., Sbleifer, A., & Vishny, R. By diversifying in several companies,some of which are risky and some of which are relatively stable, investorsmay realize lower overall profitability if the growth assets performpoorly, but a sharp downturn in any one asset will not result in the entireportfolio losing significant value. The EMU stands on the frontier of this global economic and financialintegration. Currencies andequity markets are driven by different economic fundamentals and marketforces. 32-41. Multinationals received some concession from the Financial AccountingStandards Board (FASB) in 1981 when FASB 52 replaced FASB 8 with regard totranslation risk, minimizing the effects of translation on financialstatements. The question of relative importance of country and industry effectscannot be fully answered, partially because this global integration isstill in progress. The Investment Horizon and Global Asset Allocation The benefit of global asset allocation depends largely on lowcorrelations between domestic and international equity markets.Autocorrelations of stock returns and business cycles cause correlationsbetween countries to also vary systematically across investment horizons.Correlations over longer holding periods are usually much lower thanmonthly or quarterly correlations. As thesemarkets account for only a small percentage of most globally diversifiedportfolios, it is usually undesirable to hedge their currency exposures.The danger of an unhedged policy is the possibility of sudden currencydepreciation. These structural models can explain much of the cross-sectional differenceof world equity market correlations. Introduction Global asset allocation has gained importance as people realize thediversification effect of international investments and the extent ofinternational equity market inefficiencies. Financial Analysts Journal, 54, pp. For the 19 developedcountries in this period, there is no strong indication that valueoutperformed growth across countries or across years. The transaction risk is now on the multinationalcompany. A sound currency management strategy should focus on the overallvolatility of investments, and further take into consideration themanager's views of currency movements and the cost of hedging. A. Choosing the appropriate capital marketcan help companies find investors interested in their offering.Speculators also make use of the various international markets for the samereason: to maximize their return. If the value premium is due to marketinefficiency and investors' psychology, the magnitude and nature ofvalue/growth spread may change over time or even disappear. 33). Fama, E. (1998, March-April). Therefore,currencies with lower interest rates should appreciate to compensateinvestors for lost interest. Hedging costs can be substantial forcurrencies with high interest rates, and should be entered into only underextreme circumstances. In reality, currencies with higher interestrates often appreciate, as high interest rates may draw in capital to thecurrency (Avsar, 1992, p. (1994, Winter). Goetzmann, W. As the market has been consistently surprised onthe positive side, growth stocks have delivered superior returns.Eventually, as the market adjusts to the modern economy and drives upprices of growth companies, the value/growth relationship may come back toits normal balance. However, it isnot clear whether this is a rational phenomenon or an indication ofinvestor overreaction. This phenomenon and theconcentration of market returns in a few large companies make this periodextremely difficult for value-oriented portfolios. Although they are more negatively correlated than not, thecorrelations vary across countries and can be positive depending ondifferent economic and market environments. For example, some researchers find that between 1975 and 1995 thedifference between the average returns on global portfolios of high and lowbook-to-market stocks is 7.68 percent per year, and value stocks outperformgrowth stocks in twelve of thirteen major markets (Griffin, 1998, p. In the short-term, exchange rates are much more volatile;speculators and short-term portfolio flows play large roles in rateuncertainty. References Avsar, S. Style indices and growthindices include all large-cap stocks, while most academic studies are basedon either cross-sectional regressions or extreme portfolios. When two countries have synchronizedbusiness cycles, stock markets tend to stay together even after longperiods of time (Freimann, 1998, p. Onemajor concern is the irregularity of value-growth indices in terms ofcompany and sector concentrations. 2-3. Theeffect of industry is later revised upward by still other analysts, whoallow the sensitivities of stocks' returns to industry and country factorsto differ across stocks. Business cycle effects also introduce regional or industrial differences.Countries such as Canada provide great diversification in the long term,while some European countries are closely related to each other and shouldbe treated as a single region for American investors (Freimann, 1998, p.39). 1983). The information in returns series seems to differ systematicallyacross holding periods, a tendency which has profound implications forglobal asset allocation. Correlationsbetween equities and currencies are usually low and even negative for manycountries. (1994). 2). Inorder to cover the transaction risk, the multinational then may sell theagreed-upon amount to a third buyer, who sells the currency in question tothe importer at the same time. There are three components of currency management in internationalequity investment: risk reduction through currency hedging; the possibilityof return enhancement; and the cost of hedging. D. The Salomon Smith Barney style indices, by expandingthe stock spectrum and striking a balance between the value and growth ofindividual stocks, are much more diversified in general ("SSB Explores,"1999, p. As far as market mistakes areconcerned, it is difficult to predict which style will outperform in aspecific year and when those mistakes will be corrected. When world economiesand financial markets are not fully integrated, correlations amonginternational equity markets remain low, and investors benefit frominternational diversification. CalSTRS shifts $29 billion. Different countries tend to organizetheir banking differently, and have different corporate cultures andfinancial needs. Return enhancement is based on opportunisticviews of currencies in the near future, and is speculative in nature.People tend to misuse the term "hedging" to include this as well.International equity investments typically use one of three hedgingstrategies: actively hedged, partially hedged, or unhedged. Investors have more investmentopportunities and potentially higher expected returns if they investglobally compared to local investment opportunities. The United Kingdom growth index has forty-two companies, with 57percent of index market capitalization concentrated in the largest fivecompanies. R. L., & Rouwenhorst, K. In contrast, other analysts hold that that the value premiumarises because the market under-values distressed stocks and overvaluesgrowth stocks. (1992, June). While it is quite likely that some industries in certain countrieshave become more global and thus invite industry-based stock valuation andinvestment management, it is difficult to believe that all companies withinindustries will become homogeneous in their management and production,regardless of national identity or geographic location. These economic driven activities are not susceptibleto daily exchange rate fluctuations and tend to be stable and slowlyevolving. Assumingthat the hedge carries with it a premium of one percent (to cover the buyeragainst changes in the rate), the multinational will receive $99 , inexchange for 1 million yen. Similarly, if reverse conditions are present,companies may want to delay payment for as long as possible in order totake full advantage of the exchange markets. Diversification has long been considered the best way for investors tobalance their risk-reward potential. How to manipulate the markets.Management Today, p. Certain anomalies and cyclicalpatterns can be exploited to enhance the returns of international equityinvestment. Countries continueto differ from one another in their social and legal infrastructures,economic institutions, and even their responses to the same financialforces. 1541-1578. These areas of vital importance to investors should bestudied and managed with great discipline and expertise when developing apersonal global asset allocation model. This "humped-shaped" term structure of correlations is generallyobserved for developed countries. Griffin, M. 6). While much of thefluctuations could be justified according to unique circumstances andrandom events, predicting these events and actual market correlations is adaunting task, but a critical task for those investors considering a globalorientation in their investment activities. An exporter who expectsthe currency of the purchasing country to drop would want payment as soonas possible if the currency of the importer is being used in order tominimize transaction risk. Importance of Global Asset Allocation Global asset allocation can add value when there are disparities amongnational economies and equity markets. As some analysts note, financial markets are subject to considerable"noise" (analysis and speculation), which makes the study of theinformation content of returns, volatilities, and correlations difficult(Jeon & von Furstenberg, 199 , p. M. Diversification can also take placeacross industries, and even across financial products. With the growth of the global economy, investors now have thepotential to diversify not only across industries and product lines, butalso across continents. Country and Industry Effects Whether the balance between country and industry effects has shiftedor will evolve further is a matter of some debate. Risk can beclassified into three types: transaction risk, translation risk, capitalmarket risk and investment risk (Avsar, 1992, p. Style benchmarks, on the other hand, include all stocks in either avalue or a growth index, and classify them according to some narrowlydefined criteria. The multinational company may accept that the importer will payat some future date the agreed upon amount in the agreed upon currency. Translation Risk Where transaction risk refers to the risk associated with changes incurrencies over the period of a single transaction, translation risk refersto the risk that multinational organizations take on when they must statetheir financial position in terms of a single currency, their "home"currency, on financial statements (Taylor, 1992, p. Pensions& Investments, pp. Correlations tend to rise during volatile market environments and canreach alarmingly high levels during financial crises such as the Asiancurrency crisis in 1997 and the Russian default in 1998. Emerging markets typically have much higher hedging costs. In the long term, currencies are strongly affected by the performanceof national economies and their trade with the rest of the world. In separate regressions, geocultural factors (language and distance),economic factors, and financial factors explain many of the correlationdifferences across countries. If the rates move so that the yen loses against the dollar,moving to perhaps 11 to the dollar, the American company will receive only$9 9,9 9 rather than the $1 million it expected. What is special about the past few years is that some companies haveexperienced extraordinary earnings and revenue growth, and economies havebecome more efficient. Conclusion Successful portfolio management combines both skill and discipline.With only limited information and little control of portfolio results,investors need to test their models and be consistent in theirimplementation. Some analysts maintain that under conditionalequilibrium, changes in expected returns or volatilities in specificmarkets will also affect the expected returns, volatilities, andcorrelations in other markets as well. Global asset allocation is abundant in opportunities andrisks; only by studying world markets in conjunction with the economic,social, and political aspects of world affairs can we see the entirety, andbe closer to the optimum solution. In the long term,value stocks should be expected to deliver better returns. N., & von Furstenberg, G. U.S News &World Report, pp. First, correlations tend to increase during financialcrises and market drops. 62). Do winnersrepeat? Some of the latest developmentsin global financial markets are tending to offset the diversificationeffect, however. Forecasting correlations is itself difficult. As with strictly domesticportfolios, global portfolios are most effective when they combine equityand debt products, and when speculative instruments are used only to thepoint of risk tolerance. Value versus growth. Short-term speculation makes the equilibrium exchange ratedifficult to determine and introduces positive autocorrelations in returnseries. (1997, may 26). 3). 6). The banking industry, onthe other hand, still is characterized more by its country despite the highmobility of capital across countries. 15-3 . Successful stylemanagement requires attention in three areas: style rotation underdifferent economic and financial environments (value does not alwaysoutperform growth); style co-movement across countries (certain countriesor regions have high style cross-correlations); and effective performancebenchmarks. To thedegree that national economies rise and fall in the global arena, theperformance of currencies may be somewhat predictable in the long run. While many analysts agree that asset allocation is one of the mostimportant decisions in portfolio management, there is considerabledifference of opinion about the differ about the extent of its importance.Many industry studies show that country selection accounts for almost allthe value-added for a typical international fund, while currency and stockdecisions add little value (Lakonishok, Sbleifer & Vishny, 1994, p. N., & Ibbotson, R. For example, uncovered interest rate parity states that theforward rate is an unbiased predictor of the future spot rate. (1994). The objective of global asset allocation is to assess thechallenges and opportunities presented by the global market and provide aconceptual framework for investment management. Correlations of daily or weekly returns are usually lower thanmonthly and quarterly correlations as well, due to the difference in returnautocorrelations (Griffin, 1998, p. So long as the American company is able tosecure higher returns than the interest rate on the loan, there isprotection against a decline in the currency rate. Ascurrencies are usually negatively correlated with foreign equities but havea substantial amount of volatility, a passive strategy calls for partialhedging, with the relative hedge ratio determined by the interplay ofcurrencies and foreign equities. In the former case, portfolio managersconsciously adjust their value/growth tilt according to market conditions.In the later case, portfolio managers stick to their areas of expertise andstyle purity, while allowing investors to balance between value and growthfunds. Performance benchmarks shouldbe well diversified, efficient, and close to investable portfolios. Specialized financial applications. However, the global market does offeralternatives (such as currency trading) not open to purely domesticinvestors, and such diversification can be effective in the long-run. Jeon, B. This kind of skewness in the indices makes them highly unreliable anddifficult to match. The challenge in today's global market is thus findingthe right level of diversity (or asset allocation) across borders as wellas financial products (Heston & Rouwenhorst, 1994, p. Currency markets are not efficient, partially because not allplayers in the markets are profit-driven. Investmentpractices vary a great deal in terms of underlying philosophies andprocesses. Freimann, E. Fund Action, p. 9 -91. With their close cultural and economic links and the signingof the Maastricht Treaty in 1992, the local economies and financial marketshave started to position themselves for the new wave of global competition,integrating with the rest of the world more effectively. A global perspective on pensionfund asset allocating. (1998). Contrarianinvestment, extrapolation and risk. Capital Market Risk When seeking to raise capital, multinational organizations have a widerange of options open to them. However, themultinational could enter into a contract with a third party to sell 1 million yen to the party in exchange for $1 million in 18 days. J. 1998). 1 percentage points per year in the United States, and 3.93percentage points per year globally. By investing in multiple economies which may nothave high levels of correlation (meaning that they perform independently ofone another), investors can achieve yet another level of diversification.Within each country, industry and company diversification can again takeplace, and investors can also invest in currencies as well as commodities,equities and bonds. 9 ). Inthe intermediate term, currencies are affected by the relativeattractiveness of capital markets, central bank policies, and businessdemand of currencies. Kaye, S. Some of the same hedging techniques used in transaction riskmanagement can be applied to translation risk management, but there areother techniques that are generally more favorable. Thisis in contrast to noting them as they occur, which can be particularlyvolatile in some economies and representative of "paper" profit or losses. To better understand the driving forces of world market integrationand the mechanism of market correlations, some analysts focus on thegeocultural, economic, and financial reasons for world market correlations. The hedging decision isdetermined by the volatilities of foreign equities and currencies, and thecorrelations between them. 3). These models can illustrate that five- to ten-yearsample correlations with monthly or quarterly return frequencies tend tohave the highest information/noise ratio and do best predicting futurecorrelations (Goetzmann & Ibbotson, 1994, p. 21. The bankingindustry in some small countries is primarily a local retail business. Analysts have concluded that for 16developed countries, market correlations have gradually been increasingover time and can be justified to a large degree by shaping geocultural,economic, and financial forces. S13 -S134. Using style benchmarks with updated data shows the effect of valueoutperformance as less consistent and less significant. Unforeseen factors can affect thenominal exchange rate, and speculators can suffer extreme losses at thesame time that they stand to make high levels of profit. Taylor, S. Global Asset Allocation Models Global asset allocation models should take into account the investor'srisk tolerance and investing horizon, and attempt to balance those factorswith the global alternatives available. 6 -68. In this way, there is no currency exchange risksince the companies will repay their loans in the same currency as it wasreceived (Smith, 1995, p. S97). Thus, correlations across international equity markets have graduallyincreased over the past decades, largely consistent with growinggeocultural, economic, and financial linkages among countries.International equity market correlations remain much lower than Americanlarge-cap and small-cap equity correlations, however, and provide a greaterdegree of diversification, especially for long-term investors.Correlations fluctuate considerably over time, and can increase duringfinancial crises and market downturns, which should be a concern for riskmanagement (Hemmerick, 1997, p. Growing internationalco-movement in stock price indexes. The worldwide effect of financial crises originating in some smallcountries and the implementation of the European Monetary Union can givethe impression that country boundaries are finally giving away to globalfinancial forces and industrial competition. 62). Wall Street & Technology, pp. Some analysts show thatcountry effects are much stronger than industry effects, and that theaverage correlation between securities within a country is higher than theaverage correlation between cross-country firms in the same industry. It is much safer to grasp the driving forces of thefinancial markets and assess the current stage of market co-movements thanto develop some sophisticated models extrapolating far into the future.There are, however, some structural models which attempt to separateinformation from noise and come up with a robust estimate of the currentmarket correlations. 6. For example, the German growth indexhas only 16 companies, and the largest five companies account for 76percent of the index capitalization as of mid-1999 ("SSB Explores," 1999,p. 21). Inthe above example, the American company might borrow 1 million yen from aJapanese bank on the same day that the sale is completed and invest thosefunds for the 18 -day period. The extreme-portfolio approach and multifactor classification of value and growthstocks are better at isolating the value-growth divergence and are close toprocesses adopted in portfolio management (Fama & French, 1997, p. A moderate deterioration in thehigh-yield market will have great impacts on the expected returns of andcorrelations among large-cap, small-cap, and government bonds. Improvements have been made in the industry, such as thelately developed Salomon Smith Barney style indexes, to incorporatemultifactor definitions of value and growth, and carefully quantify the"value" and "growth" of individual stocks. Smith, D. Currency Management There is a substantial amount of risk in currency exchange marketsbecause of their free-floating nature. Journal ofFinancial Economics, 36, pp. This is due less to generational differences than to the factthat older investors have less time to rebuild their capital and recouptheir losses from high-risk, unprofitable investments (Kaye, 1997, p. G. 15). 9-18. (1997, December 8). Instead of hedging, currency exposure can be closelymonitored. Global asset allocation requires consideration of many importantinvestment issues. Some have suggested that investors should diversify theirportfolios as well as their currency exposures globally and focus insteadon their global purchasing power ("SSB Explores," 1999, p.
If this paper is not what you are looking for, you can search again:
or
We can write a Custom Essay just for you.
Browse Essays by Subject