Why a diversified portfolio should include African assets

Abstract

We employ parametric and nonparametric cointegration approaches to investigate the extent of integration between African stock markets and the rest of the world. Long-run correlation estimates imply very low association between these two. The two distinct cointegration approaches confirm the latter through recursive estimation. The implication is that global markets have little impact on African stock markets. However, including African assets in a mean-variance portfolio would be beneficial to international investors.

Notes

¹From the stock market crash of 1987 to the collapse of the Mexican peso in 1994, speculative attacks on the Thai baht in 1997, the Russian crisis in 1998, the more recent emerging markets jitters in May/June 2006 and the more recent sub-prime mortgage burst, it is clear that growing interdependence could result in crisis spilling over from one country to another (Classens and Forbes, 2001, for a survey).

²The MSCI is computed based on market performance and contains the largest stocks in each market. The present coverage of the IFCG index exceeds 75% of total market capitalization, drawing on stocks in order of their liquidity.

³The African markets in our sample are all open to foreign investors. There are no restrictions on foreign exchange transactions and repatriation of capital. Markets such as South Africa and Egypt have global depository receipts that further allow foreigners to participate.

⁴Also Wang et al. (2003) analysed the relationship between five African markets and the United States. They employed daily, whereas we used monthly returns for reasons stated earlier. Our focus is on long-run relationships rather than on the short-run dynamics. Our period of analysis is also more recent than Wang et al. (2003) that includes not only the late 1990s' East Asian crises but also the dot com bubble.

⁵Alexander (1999b) suggested using the estimates of the cointegrating vector as weights for a long-run portfolio. However, this is not possible here because cointegration was rejected and as a result the cointegrating vector is not available.