What Forces Generate High Asset Return Correlations and Long Term Financial Market Disequilibrium in Emerging Markets? The Evidence for Bank Portfolio Risk Management Errors in Turkey

38 Pages Posted: 20 Jul 2003

Date Written: May 28, 2003

Abstract

The common explanation in the finance literature for high asset return correlations in some emerging markets is lack of information. Grossman (1976) and others proffer the hypothesis that sparse or misleading information produces high asset return correlations in some emerging markets. But we present evidence that the situation in truth is the reverse. High correlations are not the result of missing information. They contain information. They signal diversification losses, but also arbitrage gains. In two earlier articles (Dew 2002, 2003a) we develop evidence that emerging market high asset return correlations themselves constitute valuable publicly available information. In six emerging markets, high asset return correlations are associated with large short positions in minimum risk portfolios. Risk minimizing investors obeying the short sales signals would have had portfolios with substantially lower risk than the market portfolio during economic crises in these countries. Further, 2003b demonstrates that in Turkey, the existence of short positions was related to very large persistent excess returns to holding the minimum risk portfolio, an apparent disequilibrium that was a strong predictor of excess returns for the entire six year period of our sample data in Turkey. In a third article (2003b) we found another puzzle in Turkey. Turkey's banks are in the throes of a four year crisis. But we demonstrate that a hypothetical Turkish bank would have gotten by quite nicely during the period reacting to risk signals by adjusting portfolios containing only Treasury bills and cash for the entire period. Here we propose a link between the banking puzzle and the market inefficiency puzzle, producing an explanation for both market inefficiency and the confusion in the banking system. Turkey's banks, which constitute half the market value of the ISE 100, Turkey's market index, have been ignoring, or forced to ignore, pricing signals. This was an opportunity, not a problem, for the rest of the market. Finally the article argues that disequilibrium banks require different tactics in applying Value at Risk strategies than in equilibrium markets. These tactics are characterized.

Keywords: bank portfolio management, short positions, diversification, Value at Risk, emerging markets, efficient markets, behavioral finance

JEL Classification: G11, G15, G21, G28

Suggested Citation

Dew, James Kurt, What Forces Generate High Asset Return Correlations and Long Term Financial Market Disequilibrium in Emerging Markets? The Evidence for Bank Portfolio Risk Management Errors in Turkey (May 28, 2003). Available at SSRN: https://ssrn.com/abstract=412021 or http://dx.doi.org/10.2139/ssrn.412021

James Kurt Dew (Contact Author)

Northeastern University ( email )

360 Huntington Ave,
Boston, MA 02115
United States

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