Frontier Markets – A Source of Diversification
Based on a CAPM theoretical framework, this study found evidence that the market development level has an effect on the correlation between markets. The results suggest that Developed Markets have a strong correlation to Emerging Markets but not to Frontier Markets. Therefore it might not be efficient for a Developed Markets investor to solely diversify between Developed and Emerging markets.
The difference in correlation between markets of different stages of development suggests that greater diversification benefits can be obtain in less developed markets. When Frontier Markets are included in a global equity portfolio the efficient frontier shifts upwards to the left, therefore Frontier Markets should be included in a portfolio to improve the overall portfolio’s risk-return profile.
