Cross-market dynamics and optimal portfolio strategies in Latin American equity markets

Abstract

Purpose

This paper aims to investigate the return links and volatility transmission between five major equity markets of the Latin American region and the USA over the period 1993-2012.

Design/methodology/approach

The authors employ a multivariate vector autoregressive moving average – generalized autoregressive conditional heteroskedasticity (VAR-GARCH) methodology which allows for cross-market transmissions in both return and volatility. Moreover, we show how the obtained results can be used to design internationally diversified portfolios involving the Latin American assets and to analyze the effectiveness of hedging strategies.

Findings

The results point to the existence of substantial cross-market return and volatility spillovers and are thus crucial for international portfolio management in the Latin American region. However, the intensity of shock and volatility cross effects varies across the studied markets.

Research limitations/implications

The optimal weights and hedging ratios that we compute from the observed return and volatility spillovers, suggest that adding the Latin American assets helps improve the risk-adjusted return of the internationally diversified portfolios as well as reduce their risk exposure. For policymakers and market authorities, an increase in the level of shock interactions and volatility transmission between the US and Latin American equity markets as well as among these Latin American markets implies that the stability of the financial system in one country can be deeply affected by the disturbances in another country.

Originality/value

The authors extend the previous works on Latin American emerging markets by examining the extent of shock and volatility transmission as well as portfolio design and management from the point of view of both the US (global) and Latin American investors.

Citation

Arouri, M.E.H., Lahiani, A. and Nguyen, D.K. (2015), "Cross-market dynamics and optimal portfolio strategies in Latin American equity markets", European Business Review, Vol. 27 No. 2, pp. 161-181. https://doi.org/10.1108/EBR-04-2013-0069