Risk-Adjusted Performances of World Equity Indices

ABSTRACT

This article investigates whether equity indices of twenty-four emerging and twenty-eight developed markets compensate their investors equally after adjusting for total or downside risk, and examines the predictive power of reward-to-risk ratios for expected market returns. We find that when all fifty-two markets are ranked based on their alternative reward-to-risk ratios, almost all of the countries in the top (bottom) quartile are emerging (developed) markets. The pooled means of the reward-to-risk ratios are also significantly higher for emerging markets. Both portfolio and regressions analysis reveal that there is a significantly positive relation between various reward-to-risk metrics and expected market returns.

KEY WORDS:

• risk-return relationship
• downside risk
• value-at-risk
• emerging markets
• 2008 financial crisis

Notes

1. Demirtas (2006) shows that accounting for asymmetries also improves the forecasting of the level and volatility of short-term interest rates.

2. The parameters of the ST density are estimated by maximizing the log-likelihood function of R_t with respect to the parameters μ, σ, υ, and λ:

$logL=nlnb+nln\mathrm{\Gamma }\left(\frac{v+1}{2}\right)-\frac{n}{2}ln\pi -nln\mathrm{\Gamma }(v-2)-nln\mathrm{\Gamma }\left(\frac{v}{2}\right)-nln\sigma -\left(\frac{v+1}{2}\right)\sum _{t=1}^{n}ln\left(1+\frac{d_t^2}{(v-2)}\right)$

where d_t = (bz_t + a)/(1 − λs) and s is a sign dummy taking the value of 1 if bz_t + a < 0 and s = –1 otherwise.

3. These categorizations are also used by Demirtas and Zirek (2011).

4. Studies that investigate stock return predictability in an international context include Fernandez (2007), Carvalhal and de Melo Mendes (2008), Al Janabi, Hatemi and Irandoust (2010) and Atilgan and Demirtas (2013).

5. We also repeat this analysis by sorting market indices into five quintiles every month and find that the results are similar.

6. The results are similar for parametric value at risk-based Sharpe ratios and omitted to conserve space.