Predictable Risk and Returns in Emerging Markets

TLDR

Emerging‑market equity markets across Europe, Latin America, Asia, the Middle East, and Africa offer high expected returns and volatility, low correlations with developed markets that lower global portfolio risk, yet standard asset‑pricing models cannot explain their return cross‑section. Analysis shows that emerging‑market returns are more likely than developed‑market returns to be driven by local information.

Abstract

The emergence of new equity markets in Europe, Latin America, Asia, the Mideast and Africa provides a new menu of opportunities for investors. These markets exhibit high expected returns as well as high volatility. Importantly, the low correlations with developed countries' equity markets significantly reduce the unconditional portfolio risk of a world investor. However, standard global asset pricing models, which assume complete integration of capital markets, fail to explain the cross-section of average returns in emerging countries. An analysis of the predictability of the returns reveals that emerging market returns are more likely than developed countries to be influenced by local information.