Long-Term Global Market Correlations

Long-Term Global Market Correlations

Goetzmann, William N., Li, Lingfeng and Rouwenhorst, K. Geert, "Long-Term Global Market Correlations" (February 22, 2002). Yale ICF Working Paper No. 00-60; AFA 2003 Washington, DC Meetings.

Abstract:

In this paper we examine the correlation structure of the major world equity markets over 150 years. We find that correlations vary considerably through time and are highest during periods of economic and financial integration such as the late 19th and 20th centuries. Our analysis suggests that the diversification benefits to global investing are not constant, and that they are currently low compared to the rest of capital market history. We decompose the diversificaton benefits into two parts: a component that is due to variation in the average correlation across markets, and a component that is due to the variation in the investment opportunity set. There are periods, like the last two decades, in which the opportunity set expands dramatically, and the benefits to diversification are driven primarily by the existence of marginal markets. For other periods, such as the two decades following World War II, risk reduction is due to low correlations among the major national markets. From this, we infer that periods of globalization have both benefits and drawbacks for international investors. They expand the opportunity set, but diversification relies increasingly on investment in emerging markets.

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