Faculty Scholarship 1994 - Present

Time-Varying Correlation of the Emerging Markets with the US Stock Market

Because of their low correlation with the US stock market, the emerging markets are attractive portfolio diversification prospects for U.S. investors. In this paper, we study the time-varying correlation patterns of 26 emerging markets with the U.S. stock market. Our findings indicate that the correlation of the emerging markets with the U.S. stock market is extremely volatile. We use the principal component analysis technique to group the emerging markets in terms of the similarities of their correlation patterns with the U.S. stock market. Stock markets with high factor loadings in the same principal component have similar correlation patterns with the U.S. stock market and these markets tend to be highly correlated. Therefore, we conclude that U.S. investors can maximize diversification benefit by investing in emerging markets with high factor loadings in different principal components.