day 2,11,12,17-24 - drivers of expected returns in im (2)

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     D    r   a    f    t FALL 2000 EMERGING MARKETS QUARTERLY 1 W hat are the drivers of average returns in international mar- kets? Are the sources of risk that impact developed mar- ket returns the same as the risk factors that affect emerging market returns? These are the questions explored in this study. The work is closely related to Harvey [1995a, 1995b] and to Estrada [2000], who examines a number of risk measures and relates these measures to emerging market returns. The difference is that we expand the list of risk metrics, and examine both developed and emerging market returns. There are many reasons to believe that the sources of risk in emerging and devel- oped markets may differ. Harvey [1995a] demonstrates that the pricing relationships that show some positive success in developed markets fail in emerging markets. Bekaert and Harvey [1995] argue that emerging and devel- oped markets cannot be t reated similar ly . They propose an asset pricing framework that allows for time-varying integration. Indeed, the pres- ence of barriers to international investment as documented in Bekaert [1995] immediately suggests that risk factors will differ across developed and emerging markets. I examine a comprehensive list of 18 risk factors, and analyze whether these risk factors explain expected returns in 47 different mar- kets. In much of the analysis, I present three sets of results: developed markets, emerging mar- kets, and all markets. The idea is to determine if the same risk factors explain expected returns in developed and emerging markets. I. DATA AND RISK METRICS SUMMARY ANALYSIS Sample I examine average returns and risk in a sample of 47 countries using data from Mor- gan Stanley Capital International (MSCI). The sample consists of 28 emerging markets and 19 developed markets. Emerging market data are also available from the International Finance Corporation (IFC). When I replicate a num- ber of the emerging markets analyses with the IFC data, I find little difference between the IFC and MSCI samples. The data are sampled between January 1988 and December 1999. There are a num- ber of emerging markets whose data do not begin until later, but I include only markets that have a history at least from January 1995. Risk Metrics A variety of risk metrics are used to explain the average returns. The notation is detailed here. For example , the raw materials I am working with are the average total returns in U.S. dollars for country i, which I express as E[R i ]. Drivers of Expected Returns in International Markets CAMPBELL R. HARVEY CAMPBELL R. HARVEY is the J. Paul Sticht professor of interna- tional business at Duke University, and a research associate with the National Bureau of Economic Research in Cam- bridge, Massachusetts.

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    FALL 2000 EMERGING MARKETS QUARTERLY 1

    What are the drivers of averagereturns in international mar-kets? Are the sources of riskthat impact developed mar-

    ket returns the same as the risk factors thataffect emerging market returns? These are thequestions explored in this study.

    The work is closely related to Harvey[1995a, 1995b] and to Estrada [2000], whoexamines a number of risk measures and relatesthese measures to emerging market returns.The difference is that we expand the list of riskmetrics, and examine both developed andemerging market returns.

    There are many reasons to believe thatthe sources of risk in emerging and devel-oped markets may differ. Harvey [1995a]demonstrates that the pricing relationshipsthat show some positive success in developedmarkets fail in emerging markets. Bekaert andHarvey [1995] argue that emerging and devel-oped markets cannot be treated similarly. Theypropose an asset pricing framework that allowsfor time-varying integration. Indeed, the pres-ence of barriers to international investment asdocumented in Bekaert [1995] immediatelysuggests that risk factors will differ acrossdeveloped and emerging markets.

    I examine a comprehensive list of 18 riskfactors, and analyze whether these risk factorsexplain expected returns in 47 different mar-kets. In much of the analysis, I present three setsof results: developed markets, emerging mar-

    kets, and all markets. The idea is to determineif the same risk factors explain expected returnsin developed and emerging markets.

    I. DATA AND RISK METRICS SUMMARY ANALYSIS

    Sample

    I examine average returns and risk in asample of 47 countries using data from Mor-gan Stanley Capital International (MSCI). Thesample consists of 28 emerging markets and 19developed markets. Emerging market data arealso available from the International FinanceCorporation (IFC). When I replicate a num-ber of the emerging markets analyses with theIFC data, I find little difference between theIFC and MSCI samples.

    The data are sampled between January1988 and December 1999. There are a num-ber of emerging markets whose data do notbegin until later, but I include only marketsthat have a history at least from January 1995.

    Risk Metrics

    A variety of risk metrics are used toexplain the average returns. The notation isdetailed here. For example, the raw materialsI am working with are the average total returnsin U.S. dollars for country i, which I expressas E[Ri].

    Drivers of Expected Returns in International Markets

    CAMPBELL R. HARVEY

    CAMPBELL R.HARVEYis the J. Paul Sticht professor of interna-tional business at Duke University, anda research associate with the NationalBureau of EconomicResearch in Cam-bridge, Massachusetts.

  • One-Factor Market Model. Using a world versionof a single-factor model, where Rmt denotes the return onthe MSCI world index, I estimate the regression:

    Rit rft = ai + bi[Rmt rft] + eit (1)

    where rft is the U.S. 30-day Treasury bill rate, and eit is theresidual. Also, note that emt = Rmt Avg(Rmt) is used later.

    SR (systematic risk) is the beta, bi in equation(1). TR (total risk) is the standard deviation of countryreturn i. IR (idiosyncratic risk) is the standard devia-tion of the residual eit. The one-factor model is studiedin Harvey [1995a, 1995b] and Bekaert and Harvey[1995].

    Size. For size (market capitalization), we take the nat-ural log of average market capitalization over the relevantperiod for each country. This variable is studied in Bekaert,Erb, Harvey, and Viskanta [1997] and Estrada [2000].

    Semistandard Deviations. The formula for semi-standard deviation is:

    (2)

    Semimean is the semistandard deviation with B =average returns for the market. Semi-rf is the semistandarddeviation with B = U.S. risk-free rate. Semi-0 is thesemistandard deviation with B = 0.

    These variables are studied in Estrada [2000].Downside Beta Measures. Down-iw is the coef-

    ficient from the market model using observations whencountry returns and world returns are simultaneouslynegative. Down-w is the coefficient from the marketmodel using observations when world returns are nega-tive. The first variable is studied in Estrada [2000]. Thesecond beta has not been studied before.

    Value at risk. VaR is a value at risk measure. It is thesimple average of returns below the 5th percentile level.This variable is examined in Estrada [2000].

    Skewness. Skew is the unconditional skewness ofreturns. It is calculated by taking the Mean(ei

    3) divided bythe [Standard Deviation of (ei)]

    3. Skew 5%: [(Return atthe 95th Percentile level mean return) (Return at 5thPercentile Level Mean Return)] - 1.

    Coskew1 represents coskewness definition 1. It iscalculated by (sum up ei em

    2)/T and divide by [squareroot of (sum of (ei

    2)/T)] [(sum of (em2)/T)].Coskew2

    represents coskewness definition 2. It is calculated by

    (Sum up ei em2)/T and divide by [standard deviation of

    (em)]3.These variables are examined in Harvey and Sid-

    dique [1999, 2000a, 2000b].Spread. Kurt is the kurtosis of the return distribution.

    Kurtosis is documented in Bekaert and Harvey [1997] aswell as Bekaert, Erb, Harvey, and Viskanta [1998].

    Political and Country Risk. ICRGC is the log of theaverage monthly International Country Risk Guides(ICRG) country risk composite. CCR is the log of theaverage semiannual country risk rating published by Insti-tutional Investor. ICRGP is the log of the average monthlyICRG political risk ratings.

    These variables are studied in Erb, Harvey, andViskanta [1996a, 1996b] as well as Bekaert, Erb, Harvey,and Viskanta [1997].

    II. SUMMARY STATISTICS

    Exhibit 1A (emerging markets) and Exhibit 1B(developed markets) present some summary statistics forthe risk measures over the complete sample for eachcountry. We report the mean monthly U.S. dollar returnsas well as the geometric mean return and the uncondi-tional correlation with the MSCI world in addition to theaverage values of the risk measures.

    The last row of each exhibit reports the average acrossall markets. We see the usual characteristics. Emergingmarkets are more volatile and generally have more risk onthe downside (as measured by the semivariance, VaR,downside betas). In addition, the coskewness measures foremerging markets are more negative, suggesting that thesemarkets are contributing to the negative skewness of adiversified portfolio.

    Exhibits 2A-2C present the correlation matrices ofthe risk measures in developed countries, emergingmarkets, and all countries. There are some interestingfindings.

    Total risk and idiosyncratic risk are 99% correlatedacross emerging markets and 93% correlated in devel-oped markets. The three semivariance measures all havemore than 90% correlation with total risk in both emerg-ing and developed markets. VaR is at least -86% corre-lated with total risk in emerging and developed markets.The skewness measures are relatively little correlatedwith the other risk measures.

    2 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    Semi B R B Bt- = - < (1/ T) for all Rt=1T

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    EX

    HI

    BI

    T1

    BS

    um

    mar

    y S

    tati

    stic

    s (m

    onth

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    turn

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    elop

    ed M

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    I D

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    : Geo

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    rela

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    etur

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    yste

    mat

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    eta)

    ; TR

    : Tot

    al r

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    R: I

    dios

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    atic

    risk

    ; Mca

    p: A

    ver-

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    Mar

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    apita

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    ion;

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    e: L

    og o

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    idev

    iatio

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    mea

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    r f: S

    emid

    evia

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    with

    res

    pect

    to r

    isk-f

    ree

    rate

    ; Sem

    i-0:

    Sem

    ide-

    viat

    ion

    with

    res

    pect

    to 0

    ; Dow

    n-

    iw: D

    owns

    ide

    beta

    cal

    cula

    ted

    usin

    g ob

    serv

    atio

    ns w

    hen

    coun

    try

    inde

    x an

    d w

    orld

    inde

    x fa

    ll sim

    ulta

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    owns

    ide

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    cal

    cula

    ted

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    g ob

    serv

    atio

    ns w

    hen

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    dex

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    ; VaR

    : Val

    ue a

    t risk

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    w: S

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    ness

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    w5%

    : Ske

    wne

    ss c

    alcu

    late

    d us

    ing

    form

    ula

    1; C

    oske

    w1:

    Cos

    kew

    ness

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    dex

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    g fo

    r-m

    ula

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    : Cos

    kew

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    g fo

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    urto

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    : Ave

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    site

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    try

    risk

    ; CC

    R: A

    vera

    ge C

    CR

    cou

    ntry

    risk

    ; IC

    RG

    P: IC

    RG

    Ppo

    litic

    al r

    isk; S

    tart

    : Dat

    a st

    art

    date

    .

  • III. REGRESSION ANALYSIS

    Bivariate Regressions

    The main regression results are presented in Exhibit3. The regressions are illustrated 18 sets of graphs in Exhibit4. These regressions examine the bivariate relation betweenthe average returns and the average risk measures.

    I should emphasize that we are comparing averagesto averages over the same time period. This is consistentwith some of the early tests of asset pricing models, suchas Black, Jensen, and Scholes [1972]. There is a substan-tial literature, beginning with Harvey [1991], however,that suggests that in an international context time varia-tion in the risk and returns measures is very important.Nevertheless, this unconditional analysis should proveinteresting.

    The first set of regressions is the classic worldCAPM. The analysis shows a significant relation when all47 countries are included with an R2 of 27%. Interestingly,the intercept is not significantly different from zero. Thisevidence would seem to support the CAPM.

    A closer inspection reveals that all of the explanatorypower is coming from emerging markets. The regressionsuggests that there is a 0% R2 for developed markets.

    But here is where the graphic analysis is especiallyinsightful. The poor fit for developed markets is driven byone point; Japan has a beta of 1.41 and an average returnclose to zero. If this single observation is excluded, the fitof the developed countries dramatically improves andshows an R2 of 27%. Hence, the CAPM fares reasonablywell in this analysis.

    The fit for the emerging markets might seem sur-prising, given the results in Bekaert and Harvey [1995] andHarvey [1995a], but remember that the sample is for1988-1999. During the early part of this period, many ofthe emerging markets liberalized, and the evidence inBekaert and Harvey [2000] would suggest that these mar-kets have become more correlated with the world.

    The second risk measure is total risk. Asset pricingtheory says that only systematic risk, or the part of vari-ance that contributes to a well-diversified portfolios vari-ance, should be important. The regressions suggest thattotal variance can account for 52% of the variation in theemerging market returns. Variance explains practicallynone of the developed market returns. A combined anal-ysis is heavily influenced by emerging markets returns.

    The results for the third risk measure, idiosyncraticrisk, are similar to total risk.

    4 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    E[R

    ]SR

    TRIR

    Size

    Sem

    imea

    nSe

    mi -

    r fSe

    mi-0

    Dow

    n-b

    iwD

    own-

    b

    wVa

    Rsk

    ewsk

    ew5%

    cosk

    ew1

    cosk

    ew2

    kurt

    ICR

    GC

    CC

    RIC

    RG

    P

    E[R

    ]1.

    000

    SR0.

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    389

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    31.

    000

    Size

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    000

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    651

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    Dow

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    929

    1.00

    0

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    .624

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    0.44

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    1.00

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    000

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    091.

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    ICR

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    100.

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    750.

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    1.00

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    CR

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    000

    ICR

    GP

    0.22

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    61-0

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    0.01

    80.

    127

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    60.

    350

    1.00

    0

    EX

    HI

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    ross

    -Sec

    tion

    An

    alys

    is C

    orre

    lati

    on M

    atri

    xD

    evel

    oped

    Cou

    ntr

    ies

  • FALL 2000 EMERGING MARKETS QUARTERLY 5

    EX

    HI

    BI

    T2

    BC

    ross

    -Sec

    tion

    An

    alys

    is C

    orre

    lati

    on M

    atri

    xE

    mer

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    g M

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    trie

    s

    E[R

    ]SR

    TR

    IRSi

    zeSe

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    Sem

    i - r

    fSe

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    RIC

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    P

    E[R

    ]1.

    000

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    01.

    000

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    0.30

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    0.09

    21.

    000

    Sem

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    0.74

    60.

    966

    0.93

    70.

    187

    1.00

    0Se

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    00.

    724

    0.93

    20.

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    1.00

    0Se

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    0.72

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    31.

    000

    1.00

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    own-

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    0.66

    10.

    439

    0.36

    10.

    201

    0.54

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    508

    0.51

    11.

    000

    Dow

    n-b

    w0.

    507

    0.79

    40.

    593

    0.51

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    246

    0.73

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    0.72

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    837

    1.00

    0

    VaR

    -0.5

    56-0

    .761

    -0.9

    01-0

    .865

    -0.2

    27-0

    .965

    -0.9

    77-0

    .978

    -0.5

    64-0

    .775

    1.00

    0sk

    ew0.

    469

    0.12

    60.

    480

    0.50

    9-0

    .129

    0.26

    50.

    182

    0.18

    1-0

    .024

    -0.1

    08-0

    .153

    1.00

    0sk

    ew5%

    0.09

    2-0

    .241

    0.18

    50.

    255

    -0.1

    680.

    062

    0.04

    20.

    038

    -0.5

    24-0

    .307

    0.03

    40.

    337

    1.00

    0co

    skew

    1-0

    .054

    0.04

    80.

    184

    0.19

    0-0

    .020

    0.11

    40.

    136

    0.13

    2-0

    .536

    -0.3

    54-0

    .056

    0.16

    20.

    248

    1.00

    0co

    skew

    2-0

    .286

    0.00

    8-0

    .137

    -0.1

    59-0

    .086

    -0.1

    66-0

    .129

    -0.1

    32-0

    .502

    -0.4

    340.

    197

    -0.0

    230.

    055

    0.87

    51.

    000

    kurt

    0.40

    10.

    194

    0.41

    40.

    429

    0.03

    10.

    221

    0.15

    50.

    155

    0.00

    9-0

    .085

    -0.1

    970.

    858

    0.17

    90.

    155

    -0.0

    111.

    000

    ICR

    GC

    -0.0

    940.

    017

    -0.2

    65-0

    .295

    0.25

    3-0

    .281

    -0.2

    95-0

    .294

    -0.0

    24-0

    .221

    0.27

    30.

    135

    -0.0

    74-0

    .152

    -0.0

    200.

    161

    1.00

    0C

    CR

    -0.1

    320.

    022

    -0.0

    21-0

    .029

    0.47

    1-0

    .029

    0.00

    0-0

    .002

    -0.1

    13-0

    .169

    0.04

    20.

    050

    -0.0

    420.

    165

    0.16

    1-0

    .001

    0.65

    11.

    000

    ICR

    GP

    0.16

    90.

    119

    -0.0

    81-0

    .113

    0.25

    9-0

    .093

    -0.1

    41-0

    .139

    0.12

    4-0

    .041

    0.10

    40.

    214

    -0.0

    24-0

    .283

    -0.2

    440.

    259

    0.90

    20.

    499

    1.00

    0

    E[R

    ]SR

    TR

    IRSi

    zeSe

    mim

    ean

    Sem

    i - r

    fSe

    mi-

    0D

    own-

    b

    iwD

    own-

    b

    wV

    aRsk

    ewsk

    ew5%

    cosk

    ew1

    cosk

    ew2

    kurt

    ICR

    GC

    CC

    RIC

    RG

    P

    E[R

    ]1.

    000

    SR0.

    519

    1.00

    0T

    R0.

    642

    0.51

    41.

    000

    IR0.

    595

    0.39

    50.

    990

    1.00

    0Si

    ze0.

    018

    0.17

    1-0

    .394

    -0.4

    671.

    000

    Sem

    imea

    n0.

    616

    0.58

    20.

    980

    0.96

    0-0

    .368

    1.00

    0Se

    mi -

    rf

    0.48

    80.

    549

    0.95

    90.

    945

    -0.4

    050.

    988

    1.00

    0Se

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    00.

    489

    0.55

    10.

    959

    0.94

    4-0

    .405

    0.98

    81.

    000

    1.00

    0D

    own-

    b

    iw0.

    491

    0.61

    60.

    515

    0.45

    7-0

    .127

    0.59

    30.

    566

    0.56

    91.

    000

    Dow

    n-b

    w0.

    515

    0.75

    10.

    624

    0.55

    7-0

    .091

    0.72

    60.

    710

    0.71

    20.

    854

    1.00

    0

    VaR

    -0.5

    16-0

    .586

    -0.9

    40-0

    .920

    0.36

    2-0

    .977

    -0.9

    85-0

    .986

    -0.6

    16-0

    .756

    1.00

    0sk

    ew0.

    442

    0.09

    90.

    530

    0.54

    9-0

    .305

    0.37

    60.

    326

    0.32

    50.

    067

    -0.0

    09-0

    .302

    1.00

    0sk

    ew5%

    0.11

    7-0

    .137

    0.31

    90.

    359

    -0.2

    840.

    234

    0.22

    90.

    225

    -0.3

    14-0

    .143

    -0.1

    670.

    359

    1.00

    0co

    skew

    1-0

    .149

    0.06

    7-0

    .128

    -0.1

    680.

    308

    -0.1

    74-0

    .168

    -0.1

    72-0

    .540

    -0.3

    900.

    217

    0.05

    90.

    103

    1.00

    0co

    skew

    2-0

    .339

    0.01

    9-0

    .376

    -0.4

    170.

    310

    -0.3

    97-0

    .380

    -0.3

    82-0

    .568

    -0.5

    030.

    424

    -0.1

    35-0

    .054

    0.84

    61.

    000

    kurt

    0.40

    60.

    157

    0.48

    80.

    501

    -0.2

    210.

    353

    0.31

    30.

    314

    0.11

    90.

    022

    -0.3

    420.

    822

    0.21

    8-0

    .061

    -0.1

    731.

    000

    ICR

    GC

    -0.2

    130.

    009

    -0.6

    08-0

    .660

    0.59

    2-0

    .608

    -0.6

    28-0

    .629

    -0.2

    25-0

    .333

    0.60

    4-0

    .179

    -0.2

    430.

    198

    0.32

    6-0

    .170

    1.00

    0C

    CR

    -0.2

    400.

    010

    -0.5

    32-0

    .586

    0.72

    8-0

    .528

    -0.5

    36-0

    .537

    -0.2

    87-0

    .315

    0.53

    7-0

    .236

    -0.2

    350.

    360

    0.44

    4-0

    .276

    0.86

    71.

    000

    ICR

    GP

    -0.0

    390.

    067

    -0.5

    11-0

    .567

    0.57

    3-0

    .510

    -0.5

    51-0

    .551

    -0.1

    42-0

    .227

    0.51

    9-0

    .129

    -0.2

    100.

    121

    0.18

    9-0

    .111

    0.95

    70.

    800

    1.00

    0

    EX

    HI

    BI

    T2

    CC

    ross

    -Sec

    tion

    An

    alys

    is C

    orre

    lati

    on M

    atri

    xA

    ll C

    oun

    trie

    s

    MSC

    I D

    ata.

    E[R

    ]: M

    ean

    retu

    rns;

    SR:

    Syst

    emat

    ic r

    isk (

    Bet

    a);

    TR

    : T

    otal

    risk

    ; IR

    : Id

    iosy

    ncra

    tic r

    isk;

    Size

    : Lo

    g of

    ave

    rage

    mar

    ket

    cap;

    Sem

    imea

    n: S

    emid

    evia

    tion

    with

    res

    pect

    to

    mea

    n; S

    emi-

    r f: S

    emid

    evia

    tion

    with

    res

    pect

    to r

    isk-f

    ree

    rate

    ; Sem

    i-0:

    Sem

    idev

    iatio

    n w

    ith r

    espe

    ct to

    0; D

    own-

    iw

    : Dow

    nsid

    e be

    ta c

    alcu

    late

    d us

    ing

    obse

    rvat

    ions

    whe

    n co

    untr

    y in

    dex

    and

    wor

    ld in

    dex

    fall

    simul

    tane

    ously

    ; Dow

    n-

    w: D

    owns

    ide

    beta

    cal

    cula

    ted

    usin

    g ob

    serv

    atio

    ns w

    hen

    wor

    ld in

    dex

    falls

    ; VaR

    : Val

    ue a

    t risk

    ; ske

    w: S

    kew

    ness

    , ske

    w5%

    : Ske

    wne

    ss c

    al-

    cula

    ted

    usin

    g fo

    rmul

    a 1;

    Cos

    kew

    1: C

    o-sk

    ewne

    ss w

    ith w

    orld

    inde

    x us

    ing

    form

    ula

    2, C

    oske

    w-2

    : Cos

    kew

    with

    wor

    ld in

    dex

    usin

    g fo

    rmul

    a 3;

    kur

    t: K

    urto

    sis; I

    CR

    GC

    : Log

    of a

    ver-

    age

    ICR

    G: c

    ompo

    site

    coun

    try

    risk

    ; CC

    R: L

    og o

    f ave

    rage

    CC

    R c

    ount

    ry r

    isk, I

    CR

    GP:

    Log

    of I

    CR

    P po

    litic

    al r

    isk.

  • 6 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    Risk Variable c0 p-value c1 p-value R2 Adj-R2SR 0.7777 0.091 0.1126 0.807 0.004 -0.055TR 0.9277 0.052 -0.0076 0.919 0.001 -0.058IR 0.9155 0.019 -0.0071 0.925 0.001 -0.058Size 1.0041 0.007 -0.0244 0.704 0.009 -0.050Semimean 0.9274 0.070 -0.0107 0.925 0.001 -0.058Semi - rf 1.3345 0.004 -0.1220 0.271 0.071 0.016Semi-0 1.3063 0.004 -0.1214 0.279 0.069 0.014Down-biw 0.8317 0.012 0.0624 0.857 0.002 -0.057

    Down-bw 0.6351 0.066 0.2310 0.436 0.036 -0.021

    VaR 1.0930 0.011 0.0182 0.580 0.018 -0.039skew 0.9309 0.000 -0.2259 0.364 0.049 -0.007skew5% 0.8909 0.000 -0.1423 0.850 0.002 -0.057coskew1 0.8474 0.000 -0.6217 0.255 0.075 0.021coskew2 0.8419 0.000 -0.5410 0.274 0.070 0.015kurt 1.0414 0.016 -0.0387 0.681 0.010 -0.048ICRGC 3.0763 0.777 -0.4956 0.840 0.003 -0.056CCR 3.5383 0.469 -0.6027 0.586 0.018 -0.040ICRGP -7.2269 0.413 1.8384 0.359 0.050 -0.006

    E X H I B I T 3 ABivariate RegressionsDeveloped Countries

    Risk Variable c0 p-value c1 p-value R2 Adj-R2SR 0.3699 0.272 1.0050 0.002 0.319 0.293TR -0.8754 0.059 0.1813 0.000 0.517 0.499IR -0.7778 0.107 0.1831 0.000 0.470 0.450Size 0.6242 0.202 0.2704 0.118 0.092 0.057Semimean -0.8811 0.084 0.2792 0.000 0.464 0.444Semi - rf -0.4945 0.412 0.2520 0.003 0.285 0.258Semi-0 -0.4459 0.447 0.2526 0.003 0.286 0.259Down-biw 0.2849 0.484 0.8893 0.007 0.250 0.221

    Down-bw 0.4131 0.258 0.5713 0.006 0.259 0.230

    VaR -0.4617 0.409 -0.0780 0.002 0.312 0.286skew 0.8635 0.003 0.6561 0.012 0.220 0.190skew5% 1.2288 0.000 0.5588 0.639 0.009 -0.030coskew1 1.2324 0.002 -0.4184 0.781 0.003 -0.035coskew2 0.9742 0.004 -0.7513 0.140 0.082 0.047kurt 0.3654 0.447 0.1618 0.035 0.160 0.128ICRGC 5.9795 0.532 -1.1071 0.625 0.009 -0.029CCR 3.3286 0.249 -0.5460 0.478 0.020 -0.018ICRGP -5.2259 0.495 1.5644 0.395 0.028 -0.009

    E X H I B I T 3 BBivariate RegressionsEmerging Countries

  • The fourth risk measure is size. Size could be relatedto liquidity and the amount of information available in themarket, which are legitimate risk factors. We find thatthere is little relation between the average internationalreturns and size.

    The fifth through seventh measures are semivariancemeasures. All are similar, and from Exhibit 2 we knowthey are all highly correlated with total variance. We findthat the semivariance measures account for a substantialpart of the variation in the emerging market returns butnot the developed market returns.

    The eighth and ninth measures are downside betas.There is some relation between the downside betas andthe emerging market returnsbut little relation with thedeveloped market returns.

    The tenth measure is a value at risk measure. TheVaR measures the mean return in the 5% tail of the dis-tribution. If this type of risk is priced, one would expecta highly negative VaR (high risk) to command a high aver-age return. This is exactly what we see for emergingmarketsbut not developed markets. Notice that theslope of the line in the Exhibit 4J Emerging Markets

    graph is negative, implying that a more negative VaRimplies a higher expected return in emerging markets.

    Harvey and Siddique [2000a] posit that investors careabout the skewness of their portfolio. Their model isbased on the work of Rubinstein [1973] and Kraus andLitzenberger [1976]. In this world, investors value the con-tribution to the skewness of the portfolio, or the coskew-ness. That is, if an asset contributes positive skewness toa diversified portfolio (high coskewness), that asset will bevaluable and will have a high price (low expected return).If the asset contributes negative skewness (negativecoskewness), to get investors to purchase this asset theprice must drop ( higher expected return).

    So, in the world of the augmented CAPM, coskew-ness should count, and skewness itself should not. This isanalogous to beta and variance. In the CAPM, it is onlythe beta that is rewarded, not the total volatility. To beconsistent, only the systematic part of skewness (thecoskewness) should command a reward.

    When we examine the two total skewness measures, wesee a positive relation for emerging markets but not devel-oped markets. This is similar to what we see for total volatil-

    FALL 2000 EMERGING MARKETS QUARTERLY 7

    Risk Variable c0 p-value c1 p-value R2 Adj-R2SR 0.2480 0.325 0.9514 0.000 0.271 0.249TR -0.1256 0.612 0.1318 0.000 0.422 0.409IR 0.0934 0.693 0.1207 0.000 0.365 0.351Size 1.1247 0.001 0.0031 0.968 0.000 0.022Semimean -0.1784 0.512 0.2070 0.000 0.389 0.376Semi - rf 0.0813 0.789 0.1832 0.000 0.247 0.230Semi-0 0.1170 0.691 0.1836 0.000 0.248 0.232Down-biw 0.2769 0.289 0.8451 0.000 0.244 0.227

    Down-bw 0.3493 0.135 0.5758 0.000 0.269 0.253

    VaR 0.0753 0.793 -0.0583 0.000 0.275 0.259skew 0.8478 0.000 0.5886 0.002 0.198 0.180skew5% 1.0650 0.000 0.6623 0.421 0.015 -0.007coskew1 1.0229 0.000 -0.8703 0.300 0.024 0.002coskew2 0.8964 0.000 -0.8121 0.018 0.118 0.098kurt 0.3226 0.289 0.1586 0.004 0.167 0.149ICRGC 8.2620 0.081 -1.6560 0.130 0.050 0.029CCR 3.4683 0.012 -0.5851 0.084 0.065 0.044ICRGP 2.4870 0.538 -0.3163 0.737 0.003 -0.020

    E X H I B I T 3 CBivariate RegressionsAll Countries

    E[Ri]: Mean return; Riski = Risk Variable; SR: Systematic risk (Beta); TR: Total risk; IR: Idiosyncratic risk; Size: Log of average market cap;Semimean: Semideviation with respect to mean; Semi-rf: Semideviation with respect to risk-free rate; Semi-0: Semideviation with respect to 0;Down-iw: Downside beta calculated using observations when country index and world index fall simultaneously; Down-w: Downside beta cal-culated using observations when world index falls; VaR: Value at risk; skew: Skewness; skew5%: Skewness calculated using formula 1; Coskew1:Co-skewness with world index using formula 2; Coskew-2: Coskew with world index using formula 3; kurt: Kurtosis; ICRGC: Log of averageICRG composite country risk; CCR: Log of average CCR country risk, ICRGP: Log of ICRP political risk.

  • 8 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    EX

    HIB

    IT 4

    A -

    Sys

    tem

    atic

    Ris

    kA

    ll C

    ount

    ries

    E

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    B -

    Tot

    al R

    isk

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    C -

    Idio

    sync

    rati

    c R

    isk

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    y =

    1.01

    14x

    + 0.

    2271

    R2 =

    0.3

    101

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    00Sy

    stem

    atic

    Ris

    k

    Mean Returns

    y =

    1.00

    5x +

    0.3

    699

    R2 =

    0.3

    193

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    00Sy

    stem

    atic

    Ris

    k

    Mean Returns

    y =

    0.97

    64x

    + 0.

    046

    R2 =

    0.2

    656

    0

    0.51

    1.52 0

    .00

    0.50

    1.00

    1.50

    Syst

    emat

    ic R

    isk

    Mean Returns

    y =

    0.13

    18x

    - 0.

    1256

    R2 =

    0.4

    221

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    025

    .00

    30.0

    0T

    otal

    Ris

    k

    Mean Returns

    y =

    0.18

    13x

    - 0.

    8754

    R2 =

    0.5

    172

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    025

    .00

    30.0

    0T

    otal

    Ris

    k

    Mean Returns

    y =

    -0.0

    076x

    + 0

    .927

    7

    R2 =

    0.0

    006

    0

    0.51

    1.52 0

    .00

    2.00

    4.00

    6.00

    8.00

    10.0

    0T

    otal

    Ris

    k

    Mean Returns

    y =

    0.12

    07x

    + 0.

    0934

    R2 =

    0.3

    65

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    025

    .00

    Idio

    sync

    rati

    c R

    isk

    Mean Returns

    y =

    0.18

    32x

    - 0.

    7778

    R2 =

    0.4

    699

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    025

    .00

    Idia

    sync

    rati

    c R

    isk

    Mean Returns

    y =

    -0.0

    071x

    + 0

    .915

    5

    R2 =

    0.0

    005

    0

    0.51

    1.52 0

    .00

    2.00

    4.00

    6.00

    8.00

    Idio

    sync

    rati

    c R

    isk

    Mean Returns

  • FALL 2000 EMERGING MARKETS QUARTERLY 9

    EX

    HIB

    IT 4

    D -

    Size

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    E -

    Sem

    ivar

    ianc

    e to

    Mea

    nA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    EX

    HIB

    IT 4

    F - S

    emiv

    aria

    nce

    to R

    isk

    -Fre

    e In

    tere

    st R

    ate

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    y =

    0.22

    89x

    + 0.

    523

    R2 =

    0.0

    624

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    005.

    00Si

    ze

    Mean Returns

    y =

    0.27

    04x

    + 0.

    6242

    R2 =

    0.0

    915

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    005.

    00Si

    ze

    Mean Returns

    y =

    0.29

    39x

    + 0.

    0306

    R2 =

    0.0

    56

    0

    0.51

    1.52 0

    .00

    1.00

    2.00

    3.00

    4.00

    Size

    Mean Returns

    y =

    0.20

    7x -

    0.17

    84

    R2 =

    0.3

    893

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi -

    mea

    n

    Mean Returns

    y =

    0.27

    92x

    - 0.8

    811

    R2 =

    0.4

    644

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi-m

    ean

    Mean Returns

    y =

    -0.0

    107x

    + 0

    .927

    4

    R2 =

    0.0

    005

    0

    0.51

    1.52 0

    .00

    2.00

    4.00

    6.00

    8.00

    Sem

    i-mea

    n

    Mean Returns

    y =

    0.18

    32x

    + 0.

    0813

    R2 =

    0.2

    469

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi-r

    f

    Mean Returns

    y =

    0.25

    2x -

    0.49

    45

    R2 =

    0.2

    851

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi-r

    f

    Mean Returns

    y =

    -0.1

    22x

    + 1.

    3345

    R2 =

    0.0

    709

    0

    0.51

    1.52 0

    .00

    1.00

    2.00

    3.00

    4.00

    5.00

    6.00

    Sem

    i-rf

    Mean Returns

  • 10 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    EX

    HIB

    IT 4

    G -

    Sem

    ivar

    ianc

    e to

    Zer

    oA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    EX

    HIB

    IT 4

    H -

    Dow

    nsid

    e B

    eta,

    Wor

    ld a

    nd L

    ocal

    Mar

    ket D

    own

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    I - D

    owns

    ide

    Bet

    a, W

    orld

    Dow

    nA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    y =

    0.18

    37x

    + 0.

    117

    R2 =

    0.2

    482

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi-0

    Mean Returns

    y =

    0.25

    26x

    - 0.4

    459

    R2 =

    0.2

    863

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0Se

    mi-0

    Mean Returns

    y =

    -0.1

    214x

    + 1

    .306

    3

    R2 =

    0.0

    685

    0

    0.51

    1.52 0

    .00

    1.00

    2.00

    3.00

    4.00

    5.00

    Sem

    i-0

    Mean Returns

    y =

    0.84

    51x

    + 0.

    2769

    R2 =

    0.2

    439

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    00D

    own

    Bet

    a - i

    w

    Mean Returns

    y =

    0.88

    93x

    + 0.

    2849

    R2 =

    0.2

    502

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    00D

    own

    Bet

    a - i

    w

    Mean Returns

    y =

    0.06

    24x

    + 0.

    8317

    R2 =

    0.0

    02

    0

    0.51

    1.52 0

    .00

    0.50

    1.00

    1.50

    Dow

    n B

    eta

    - iw

    Mean Returns

    y =

    0.57

    58x

    + 0.

    3493

    R2 =

    0.2

    691

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    005.

    006.

    00D

    own

    Bet

    a -w

    Mean Returns

    y =

    0.57

    13x

    + 0.

    4131

    R2 =

    0.2

    589

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    005.

    006.

    00D

    own

    Bet

    a - w

    Mean Returns

    y =

    0.23

    1x +

    0.6

    351

    R2 =

    0.0

    361

    0

    0.51

    1.52 0

    .00

    0.50

    1.00

    1.50

    2.00

    Dow

    n B

    eta

    - w

    Mean Returns

  • FALL 2000 EMERGING MARKETS QUARTERLY 11

    EX

    HIB

    IT 4

    J - V

    alue

    at R

    isk

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    K -

    Unc

    ondi

    tiona

    l Ske

    wne

    ssA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    EX

    HIB

    IT 4

    L - S

    kew

    5%

    Tai

    lA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    y =

    -0.0

    583x

    + 0

    .075

    3

    R2 =

    0.2

    746

    -1012345

    -50.

    00-4

    0.00

    -30.

    00-2

    0.00

    -10.

    000.

    00V

    alue

    At R

    isk

    Mean Returns

    y =

    -0.0

    78x

    - 0.4

    618

    R2 =

    0.3

    122

    -1012345

    -50.

    00-4

    0.00

    -30.

    00-2

    0.00

    -10.

    000.

    00V

    alue

    At R

    isk

    Mean Returns

    y =

    0.01

    82x

    + 1.

    0932

    R2 =

    0.0

    184

    0

    0.51

    1.52

    -20.

    00-1

    5.00

    -10.

    00-5

    .00

    0.00

    Val

    ue A

    t Ris

    k

    Mean Returns

    y =

    0.58

    87x

    + 0.

    8478

    R2 =

    0.1

    978

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    00Sk

    ew

    Mean Returns

    y =

    0.65

    61x

    + 0.

    8635

    R2 =

    0.2

    202

    -1012345

    -1.0

    00.

    001.

    002.

    003.

    004.

    00Sk

    ew

    Mean Returns

    y =

    -0.2

    259x

    + 0

    .930

    9

    R2 =

    0.0

    486

    0

    0.51

    1.52

    -0.5

    00.

    000.

    501.

    001.

    50Sk

    ew

    Mean Returns

    y =

    0.66

    23x

    + 1.

    0651

    R2 =

    0.0

    145

    -1012345

    -0.4

    0-0

    .20

    0.00

    0.20

    0.40

    0.60

    Skew

    5%

    Mean Returns

    y =

    0.55

    88x

    + 1.

    2288

    R2 =

    0.0

    086

    -1012345

    -0.4

    0-0

    .20

    0.00

    0.20

    0.40

    0.60

    Skew

    5%

    Mean Returns

    y =

    -0.1

    423x

    + 0

    .890

    9

    R2 =

    0.0

    022

    0

    0.51

    1.52

    -0.2

    0-0

    .10

    0.00

    0.10

    0.20

    0.30

    0.40

    0.50

    Skew

    5%

    Mean Returns

  • 12 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    All

    Cou

    ntri

    esE

    mer

    ging

    Mar

    kets

    Dev

    elop

    ed M

    arke

    ts

    EX

    HIB

    IT 4

    N -

    Cos

    kew

    ness

    Mea

    sure

    2A

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    EX

    HIB

    IT 4

    O -

    Kur

    tosi

    sA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    y =

    -0.8

    703x

    + 1

    .022

    9

    R2 =

    0.0

    238

    -1012345

    -0.6

    0-0

    .40

    -0.2

    00.

    000.

    200.

    40C

    oske

    w1

    Mean Returns

    y =

    -0.4

    184x

    + 1

    .232

    4

    R2 =

    0.0

    03

    -1012345

    -0.6

    0-0

    .40

    -0.2

    00.

    000.

    20C

    oske

    w1

    Mean Returns

    y =

    -0.6

    217x

    + 0

    .847

    4

    R2 =

    0.0

    754

    0

    0.51

    1.52

    -0.4

    0-0

    .20

    0.00

    0.20

    0.40

    Cos

    kew

    1

    Mean Returns

    y =

    -0.8

    121x

    + 0

    .896

    4

    R2 =

    0.1

    18

    -1012345

    -1.5

    0-1

    .00

    -0.5

    00.

    000.

    50C

    oske

    w2

    Mean Returns

    y =

    -0.7

    513x

    + 0

    .974

    2

    R2 =

    0.0

    818

    -1012345

    -1.5

    0-1

    .00

    -0.5

    00.

    000.

    50C

    oske

    w2

    Mean Returns

    y =

    -0.5

    41x

    + 0.

    8419

    R2 =

    0.0

    698

    0

    0.51

    1.52

    -0.6

    0-0

    .40

    -0.2

    00.

    000.

    200.

    40C

    oske

    w2

    Mean Returns

    y =

    0.15

    86x

    + 0.

    3226

    R2 =

    0.1

    673

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0K

    urto

    sis

    Mean Returns

    y =

    0.16

    18x

    + 0.

    3654

    R2 =

    0.1

    604

    -1012345

    0.00

    5.00

    10.0

    015

    .00

    20.0

    0K

    urto

    sis

    Mean Returns

    y =

    -0.0

    387x

    + 1

    .041

    4

    R2 =

    0.0

    102

    0

    0.51

    1.52 0

    .00

    2.00

    4.00

    6.00

    8.00

    Kur

    tosi

    s

    Mean Returns

    EX

    HIB

    IT 4

    M-C

    oske

    wne

    ss M

    easu

    re 1

  • FALL 2000 EMERGING MARKETS QUARTERLY 13

    EX

    HIB

    IT 4

    P - I

    CR

    GC

    Com

    posi

    te C

    ount

    ry R

    isk

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    All

    Cou

    ntri

    es

    EX

    HIB

    IT 4

    Q -

    Inst

    itutio

    nal I

    nves

    tor

    Cou

    ntry

    Cre

    dit R

    atin

    gA

    ll C

    ount

    ries

    Em

    ergi

    ng M

    arke

    tsD

    evel

    oped

    Mar

    kets

    EX

    HIB

    IT 4

    R -

    ICR

    G P

    oliti

    cal R

    isk

    All

    Cou

    ntri

    esD

    evel

    oped

    Mar

    kets

    y =

    -1.1

    071x

    + 5

    .979

    5

    R2 =

    0.0

    093

    -1012345

    4.00

    4.10

    4.20

    4.30

    4.40

    4.50

    ICR

    G C

    ount

    ry R

    isk

    Com

    posi

    te

    Mean Returns

    y =

    -1.6

    56x

    + 8.

    262

    R2 =

    0.0

    501

    -1012345

    3.90

    4.00

    4.10

    4.20

    4.30

    4.40

    4.50

    4.60

    ICR

    G C

    ount

    ry R

    isk

    Com

    posi

    te

    Mean Returns

    y =

    -0.4

    956x

    + 3

    .076

    3

    R2 =

    0.0

    025

    0

    0.51

    1.52 4

    .30

    4.35

    4.40

    4.45

    4.50

    4.55

    ICR

    G C

    ount

    ry R

    isk

    Com

    posi

    te

    Mean Returns

    y =

    -0.5

    851x

    + 3

    .468

    3

    R2 =

    0.0

    647

    -1012345

    0.00

    1.00

    2.00

    3.00

    4.00

    5.00

    CC

    R C

    ount

    ry R

    atin

    g

    Mean Returns

    y =

    -0.3

    163x

    + 2

    .487

    R2 =

    0.0

    025

    -1012345

    3.90

    4.00

    4.10

    4.20

    4.30

    4.40

    4.50

    4.60

    ICR

    G P

    oliti

    cal R

    isk

    Mean Returns

    y =

    -0.5

    46x

    + 3.

    3286

    R2 =

    0.0

    195

    -1012345

    0.00

    1.00

    2.00

    3.00

    4.00

    5.00

    CC

    R C

    ount

    ry R

    atin

    g

    Mean Returns

    y =

    -0.6

    027x

    + 3

    .538

    4

    R2 =

    0.0

    178

    0

    0.51

    1.52 4

    .20

    4.30

    4.40

    4.50

    4.60

    CC

    R C

    ount

    ry R

    atin

    g

    Mean Returns

    y =

    1.56

    44x

    - 5.2

    269

    R2 =

    0.0

    279

    -1012345

    3.90

    4.00

    4.10

    4.20

    4.30

    4.40

    4.50

    ICR

    G P

    oliti

    cal R

    isk

    Mean Returns

    y =

    1.83

    85x

    - 7.2

    269

    R2 =

    0.0

    497

    0

    0.51

    1.52 4

    .25

    4.30

    4.35

    4.40

    4.45

    4.50

    ICR

    G P

    oliti

    cal R

    isk

    Mean Returns

    Em

    ergi

    ng M

    arke

    ts

  • ity, and is consistent with the notion that the emerging mar-kets are not fully integrated into world capital markets.

    For the coskewness measures, the results are similaracross the two methods. In both developed and emerg-ing markets, there is a negative relation, suggesting thatmore negative coskewness gets a higher expected returnwhich is what the theory would suggest.

    From an asset pricing perspective again, it is the con-tribution to kurtosis of a well-diversified portfolio (thecokurtosis) that should be priced. We do not attempt tomeasure the cokurtosis. We find a positive relationbetween kurtosis and returns in emerging markets but notin developed markets.

    The last measures are country risk ratings. Erb, Har-vey, and Viskanta [1996a, 1996b] show that there is a rela-tion between country risk ratings and subsequent returns.The analysis in Exhibit 3 is different. We are comparingaverage country risk to average returns during the sameperiod. Nevertheless, most of the results are consistent withthose of Erb, Harvey, and Viskanta.

    We find for the ICRG Composite and the Institu-tional Investor Country Credit Rating that there is a neg-ative relation in both developed and emerging markets.The relation is weak, however. The political risk measurein exhibit 4R has a positive slope, suggesting that higherpolitical risk is associated with lower expected returnswhich is counter-intuitive.

    14 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    Risk1 / Risk2 c0 p-value c1 p-value c2 p-value R2

    SR / TR 0.8522 0.1000 0.2774 0.6730 -0.0385 0.7160 0.012SR / IR 0.8177 0.1130 0.1526 0.7670 -0.0169 0.8420 0.006SR / Size 0.8946 0.1150 0.1220 0.7970 -0.0253 0.7020 0.013SR / Semimean 0.8671 0.1100 0.2681 0.6810 -0.0565 0.7280 0.011SR / Semi - rf 1.0727 0.0270 0.7604 0.1970 -0.2431 0.0970 0.166SR / Semi-0 1.0284 0.0310 0.7421 0.2070 -0.2403 0.1040 0.159SR / Down-biw 0.7699 0.1130 0.0943 0.8600 0.0304 0.9390 0.004

    SR / Down-bw 0.7115 0.1310 -0.1446 0.8010 0.2857 0.4470 0.040

    SR / VaR 0.9074 0.0650 0.4448 0.4570 0.0380 0.3760 0.053SR / skew 0.8732 0.0700 0.0607 0.8970 -0.2217 0.3920 0.050SR / skew5% 0.6725 0.2100 0.2483 0.6710 -0.3788 0.6910 0.014SR / coskew1 0.6200 0.1830 0.2397 0.6080 -0.6864 0.2330 0.091SR / coskew2 0.6446 0.1660 0.2081 0.6550 -0.5818 0.2610 0.082SR / kurt 0.9574 0.1700 0.0755 0.8760 -0.0354 0.7220 0.012SR / ICRGC 2.8540 0.7990 0.1084 0.2000 -0.4683 0.8530 0.006SR / CCR 3.3791 0.5070 0.0959 0.8390 -0.5868 0.6070 0.020SR / ICRGP -7.9100 0.3930 0.1787 0.7030 1.9555 0.3480 0.059TR / IR 0.9280 0.0790 -0.0079 0.9700 0.0003 0.9990 0.001TR / Size 1.1992 0.1230 -0.0249 0.7700 -0.0339 0.6450 0.014TR / Semimean 0.9171 0.1000 -0.0264 0.9560 0.0295 0.9680 0.001TR / Semi - r * 0.8827 0.0050 0.7752 0.0000 -1.2421 0.0000 0.658TR / Semi-0* 0.6921 0.0300 0.7319 0.0000 -0.1819 0.0000 0.611TR / Down-biw 0.9245 0.0600 -0.0262 0.7900 0.1385 0.7620 0.007

    TR / Down-bw 0.9436 0.0460 -0.1133 0.3080 0.5699 0.2060 0.099

    TR / VaR 0.8558 0.0720 0.1935 0.3080 0.0967 0.2510 0.082TR / skew 0.9160 0.0580 0.0026 0.9730 -0.2272 0.3820 0.049TR / skew5% 0.8716 0.1500 0.0035 0.9730 -0.1659 0.8740 0.002TR / coskew1 0.9235 0.0520 -0.0129 0.8620 -0.6278 0.2660 0.072TR / coskew2 0.9947 0.0400 -0.0263 0.7290 -0.5798 0.2670 0.077TR / kurt 1.1478 0.1100 -0.0150 0.8480 -0.0429 0.6660 0.013TR / ICRGC 3.1693 0.7780 -0.0081 0.9160 -0.5057 0.8450 0.003TR / CCR 4.1312 0.4510 -0.0224 0.7800 -0.7070 0.5560 0.023TR / ICRGP -7.1810 0.4330 -0.0035 0.0498 1.8327 0.3760 0.050*Extreme multicollinearity.

    f

    E X H I B I T 5 AMultiple RegressionsDeveloped Markets

  • Multivariate Regressions

    The multivariate regressions are presented in Exhibit5. These regressions use two risk factors. We concentrateon regressions with beta and one other risk factor andregressions with total risk and one other risk factor.

    If the world behaves according to the augmentedCAPM with skewness, we should have both beta andcoskewness in the regression. It turns out that this type ofregression is reasonably successful. In developed markets,the market beta has a positive coefficient, and the coskew-ness has a negative coefficient. Neither coefficient is sig-nificant at conventional levels in the regression with only19 observations.

    In the emerging markets sample, this regression ismore successful. The coefficient on the market beta is sig-nificant, and the coefficient on the coskewness measureis negative and significant, at the 10% level using the sec-ond definition of coskewness. This regression is able toexplain 40% of the emerging market returns. There are28 observations in the regression.

    In the full sample, the regression with coskewnessdefinition 2 is quite successful. Both coefficients are signif-icantly different from zero and are the right sign. The regres-sion explains 40% of the variation in the average returns.

    The alternative model is one with total variance andtotal skewness. This model does not fare well in developedmarkets; it does much better in emerging markets. The

    FALL 2000 EMERGING MARKETS QUARTERLY 15

    Risk1 / Risk2 c0 p-value c1 p-value c2 p-value R2

    SR / TR -0.8203 0.0800 0.2851 0.3870 0.1546 0.0020 0.532SR / IR -0.7703 0.1010 0.4749 0.1220 0.1436 0.0030 0.519SR / Size 0.1156 0.7980 0.9271 0.0050 0.1295 0.4040 0.338SR / Semimean -0.7869 0.1450 0.2272 0.5640 0.2401 0.0130 0.472SR / Semi - rf -0.2003 0.7430 0.6672 0.1210 0.1238 0.2720 0.352SR / Semi-0 -0.1763 0.7660 0.6641 0.1240 0.1245 0.2710 0.352SR / Down-biw 0.1567 0.6890 0.7405 0.0640 0.4000 0.3060 0.348

    SR / Down-bw 0.2985 0.4070 0.7753 0.1190 0.1825 0.5520 0.329

    SR / VaR -0.2127 0.7130 0.5912 0.1900 -0.0427 0.2260 0.359SR / skew 0.0722 0.8190 0.9142 0.0020 0.5653 0.0100 0.480SR / skew5% 0.0677 0.8600 1.1087 0.0010 1.4635 0.1490 0.375SR / coskew1 0.2511 0.5460 1.0120 0.0020 -0.6276 0.6200 0.326SR / coskew2 0.0283 0.9390 1.0088 0.0010 -0.7625 0.0720 0.404SR / kurt -0.2439 0.5900 0.9008 0.0030 0.1222 0.0660 0.407SR / ICRGC 5.5166 0.4930 1.0083 0.0020 -1.2202 0.5220 0.331SR / CCR 2.5628 0.2890 1.0108 0.0020 -0.5938 0.3580 0.342SR / ICRGP -3.5800 0.5820 0.9835 0.0030 0.9505 0.5440 0.330TR / IR -0.8258 0.0700 0.5232 0.0400 -0.3656 0.1650 0.554TR / Size -1.2669 0.0180 0.1743 0.0000 0.1879 0.1290 0.561TR / Semimean -0.8183 0.0980 0.2314 0.1010 -0.0842 0.7060 0.520TR / Semi - r -0.3113 0.4650 0.4239 0.0000 -0.4872 0.0040 0.658TR / Semi-0 -0.4206 0.3150 0.4182 0.0000 -0.4763 0.0040 0.653TR / Down-b -1.0380 0.0280 0.1560 0.0000 0.4062 0.1350 0.559

    TR / Down-b -0.8699 0.0630 0.1624 0.0010 0.1424 0.4640 0.528

    TR / VaR -0.6711 0.1500 0.2888 0.0010 0.0661 0.1350 0.559TR / skew -0.7931 0.0900 0.1618 0.0000 0.2254 0.3080 0.537TR / skew5% -0.8635 0.0690 0.1833 0.0000 -0.2512 0.7700 0.519TR / coskew1 -1.2476 0.0210 0.1903 0.0000 -1.4755 0.1660 0.554TR / coskew2 -1.0189 0.0310 0.1748 0.0000 -0.5026 0.1690 0.553TR / kurt -1.0111 0.0440 0.1684 0.0000 0.0501 0.4180 0.530TR / ICRGC -5.8392 0.4140 0.1881 0.0000 1.1570 0.4860 0.527TR / CCR 0.9363 0.6500 0.1807 0.0000 -0.4873 0.3710 0.533TR / ICRGP -9.7990 0.0710 0.1860 0.0000 2.1230 0.0980 0.568

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    E X H I B I T 5 BMultiple RegressionsEmerging Markets

  • loading on total variance is positive, and the loading onskewness is negative which is what one would expect ifthe markets are completely segmented. The two factorscan explain about 52% of the variation in the averagereturns. In the model with all countries, the total varianceremains important but the skewness measures are nolonger significant.

    Judging by R2, the best-fitting regression is the onewith total risk and a measure of semivariance, althoughthis is misleading because of the extreme collinearitybetween the semivariance measures and the total risk.

    The message of this analysis is as follows. A worldCAPM with coskewness appears to have some ability toexplain average returns in both developed and emerging

    markets. In emerging markets, the systematic risks (betaand coskewness) are not complete measures of risk. Thatis, extra variation can be explained by adding total risksto the regression. Even so, the results of Bekaert andHarvey [2000] suggest that these total risks may be becom-ing less important with capital market liberalizations.

    IV. SUMMARY

    I have examined 18 measures of risk in 47 interna-tional markets. Particular attention is paid to a measure ofdownside implied by asset pricing theory: coskewness.This risk measure captures the contribution that an assetmakes to a well-diversified portfolios total skewness. A

    16 DRIVERS OF EXPECTED RETURNS IN INTERNATIONAL MARKETS FALL 2000

    Risk1 / Risk2 c0 p-value c1 p-value c2 p-value R2

    SR / TR -0.3051 0.2370 0.4638 0.0540 0.1054 0.0000 0.470SR / IR -0.2491 0.3280 0.6110 0.0080 0.0944 0.0000 0.459SR / Size 0.3817 0.2400 0.9780 0.0000 -0.0451 0.5150 0.278SR / Semimean -0.2923 0.2900 0.4350 0.0970 0.1610 0.0010 0.427SR / Semi - rf -0.1101 0.7130 0.6483 0.0200 0.1114 0.0460 0.335SR / Semi-0 -0.0878 0.7640 0.6460 0.0210 0.1119 0.0450 0.335SR / Down-biw 0.0555 0.8360 0.6375 0.0320 0.4776 0.0840 0.320

    SR / Down-bw 0.1791 0.4770 0.5493 0.1210 0.3252 0.1300 0.309

    SR / VaR -0.0937 0.7440 0.5945 0.0360 -0.0371 0.0320 0.344SR / skew 0.0580 0.8020 0.8795 0.0000 0.5256 0.0010 0.427SR / skew5% 0.0881 0.7430 1.0000 0.0000 1.0737 0.1310 0.308SR / coskew1 0.0873 0.7460 0.9747 0.0000 -1.0720 0.1380 0.307SR / coskew2 -0.0099 0.9680 0.9638 0.0000 -0.8360 0.0040 0.396SR / kurt -0.3296 0.2950 0.8553 0.0000 0.1302 0.0080 0.381SR / ICRGC 7.5150 0.0640 0.9550 0.0000 -1.6895 0.0720 0.323SR / CCR 2.6242 0.0270 0.9561 0.0000 -0.5971 0.0400 0.339SR / ICRGP 2.5330 0.4660 0.9618 0.0000 -0.5372 0.5100 0.278TR / IR -0.4942 0.0790 0.5095 0.0020 -0.3758 0.0150 0.495TR / Size -0.9385 0.0180 0.1566 0.0000 0.1638 0.0100 0.503TR / Semimean -0.0596 0.8290 0.1963 0.0990 -0.1075 0.5750 0.426TR / Semi - r 0.2858 0.1970 0.4402 0.0000 -0.5842 0.0000 0.622TR / Semi-0 0.1582 0.4580 0.4334 0.0000 -0.5715 0.0000 0.616TR / Down-b -0.2859 0.2760 0.1092 0.0000 0.3710 0.1020 0.457

    TR / Down-b -0.1824 0.4660 0.1083 0.0010 0.2064 0.2030 0.443

    TR / VAR 0.0218 0.9290 0.2729 0.0000 0.0823 0.0240 0.486TR / skew -0.0723 0.7740 0.1168 0.0000 0.1853 0.3000 0.436TR / skew5% -0.1286 0.6050 0.1381 0.0000 -0.5315 0.4260 0.431TR / coskew1 -0.1604 0.5300 0.1299 0.0000 -0.4071 0.5340 0.427TR / coskew2 0.1218 0.6230 0.1230 0.0000 -0.2730 0.3510 0.434TR / kurt -0.2510 0.3760 0.1199 0.0000 0.0467 0.3590 0.433TR / ICRGC -9.1055 0.0530 0.1654 0.0000 2.0120 0.0560 0.469TR / CCR -1.4252 0.3100 0.1456 0.0000 0.2930 0.3470 0.434TR / ICRGP -10.7762 0.0030 0.1714 0.0000 2.4047 0.0030 0.530

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    E X H I B I T 5 CMultiple RegressionsAll Markets

  • negative coskewness would imply that adding an asset tothe portfolio will decrease the skewness of the portfolio.Given that investors like positive not negative skewness,this asset would have to have a high expected return to getinvestors to purchase it.

    Risk measures implied by asset pricing theory, inparticular world beta and coskewness, work reasonablywell in capturing the cross-section of average returns inworld markets. Yet, consistent with the evidence inBekaert and Harvey [1995], many emerging marketsappear to be impacted by total risk measures like varianceand skewness. This is consistent with their less-than-complete integration with world capital markets.

    ENDNOTES

    I wish to thank Lakshman Easwaran for his excellentresearch assistance and comments.

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