Risk-based Allocation to Frontier Equity Markets
February 14, 2012 - Equity Premium, Strategic Allocation
What is the best way to include the least developed (frontier) stock markets for portfolio diversification? In his December 2011 paper entitled “Frontier Markets: Punching Below their Weight? A Risk Parity Perspective on Asset Allocation”, Jorge Chan-Lau compares the diversification effects of frontier markets within a world equity portfolio based on risk parity and market capitalization weighting approaches. Risk parity equalizes risk contributions across equity classes by assigning the same risk budget to each asset based on co-movement between the asset’s returns and the portfolio returns. The asset allocation comparison assumes five major equity classes: U.S., European including the UK, East Asia and Far East, emerging markets and frontier markets. Co-movement of asset and portfolio returns derive from weekly return measurements over five-year rolling historical windows. Using weekly returns in U.S. dollars for each equity class based on corresponding Morgan Stanley Capital Indexes during June 2002 through November 2011, he finds that: Keep Reading