Exchange rates risk and equity portfolio diversification.

This thesis identifies and fills certain gaps in the empirical literature on the relationship between exchange rates and stock prices, and equity portfolio diversification, with the aim of providing useful information for academics, private investors, currency risk hedgers, and policy-makers. Firstly, it analyses granger-causal links between exchange rates and stock prices even at a level of stock market disaggregation not previously considered, taking into consideration a number of factors that may influence the lead/lag results. Secondly, the thesis considers whether exchange rate movements actually contribute to systematic or undiversifyable risks in national equity markets, particularly assessing the implications (thus far) of the single European currency (the euro) on the risk premiums of major equity markets, given the general perception that the EMU should reduce exchange rate and equity market risks. Several studies have advocated cross-border equity investments as a tool for reducing equity portfolio risks, despite inherent problems including exchange rate risks. Finally therefore, this thesis contributes to the literature on the diversification of equity portfolio risks by assessing the potential of home-based diversification in three developed European equity markets as an alternative to international portfolio diversification, and the potential benefits of eurozone diversification. The evidence suggests the existence of time-varying granger-causal links between exchange rates and stock prices in most countries, although the lead/lag structure for each country may differ when the stock market index is disaggregated, contradicting theoretical models. Although the EMU does not appear to have reduced the exchange rate risk premium in key member states, the same cannot be said about the equity market premium, which has reduced in three of the four member countries investigated. Finally, it appears that the potential of diversifying within the European equity market is such that any extra benefit from international equity acquisitions for diversification purposes is statistically and economically insignificant

Diversification prospects in Middle East and North Africa (MENA) equity markets: a synthesis and an update

This study investigates the extent to which Eurozone and Middle East and North Africa (MENA) equity markets are integrated, to assess any potential diversification benefits across the two sets of markets. In addition to cointegration analysis, we analyse time-varying conditional correlations, which are then modelled as a smooth transition logistic trend model to permit the determination of the speed at which the two sets of markets are becoming more or less integrated. Optimal portfolios based on a combination of equity assets in both sets of markets are constructed to assess possible gains from diversification. We compare the performances of these portfolios using a variety of performance measures, taking into account the implications of higher moments of return distribution unlike several studies. Whilst our findings do not indicate Eurozone-MENA integration, there is mixed evidence on the correlation trends between the sets of markets. Moreover, the changes in correlations occur at a very slow pace. Overall, our analysis indicates the existence of diversification benefits in MENA equity markets.