Is the potential for international diversification disappearing? A dynamic copula approach

Authors: Christoffersen, Peter F.; Errunza, Vihang R.; Jacobs, Kris; Langlois, Hugues

Abstract: 

International equity markets are characterized by nonlinear dependence and asymmetries. We propose a new dynamic asymmetric copula model to capture long-run and short-run dependence, multivariate nonnormality, and asymmetries in large cross-sections. We find that correlations have increased markedly in both developed markets (DMs) and emerging markets (EMs), but they are much lower in EMs than in DMs. Tail dependence has also increased, but its level is still relatively low in EMs. We propose new measures of dynamic diversification benefits that take into account higher-order moments and nonlinear dependence. The benefits from international diversification have reduced over time, drastically so for DMs. EMs still offer significant diversification benefits, especially during large market downturns. © 2012 The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved.

Review of Financial Studies, December 2012