With international equity correlations so high, especially during bear markets, is investing abroad worth the effort?
Yes, write Andrew Ang and Geert Bekaert, two Columbia Business School finance professors. Their paper, titled "International Asset Allocation with Regime Shifts," was awarded the first Crowell Memorial Competition by PanAgora Asset Management Inc., Boston. Named after Richard A. Crowell, the late founder of quant shop PanAgora, the new award honors the best paper in the area of quantitative finance.
In their paper, Messrs. Ang and Bekaert look at periods of high volatility and high correlation, which tend to coincide with a bear market, and periods of lower volatility and lower correlation. Their main conclusion is that international diversification pays off, even during a highly volatile bear market, and that currency hedging helps reduce risk even more.
A key finding, explained Brian Bruce, PanAgora's director of global investments, is that the paper produces a model that accounts for the link between high-volatility and high correlation periods.
That's important because the vast majority of asset modeling techniques cannot account for this finding, and "thus are inherently inferior when trying to figure out what investors do under different market conditions," Mr. Bruce said.
Given proof of the link, the paper does show that investors retreat to their home markets during volatile bear markets. It indicates, however, that there still are gains to be made from international diversification.
The paper can be found at www.panagora.com.
