Asset allocation and investment opportunities in emerging stock markets: Evidence from return asymmetry-based analysis - Zied Ftiti


The modern portfolio theory introduced by Markowitz (1952) stipulates that an investor might minimize risk while maintaining a sufficient level of return through a portfolio diversification strategy. In other words, Markowitz (1952) concludes that the risk of a portfolio of well-diversified stocks is lower than the intrinsic risk of any one of its non-correlated individual stocks. Over the past few decades, in addition to the role of the first and second moments in asset pricing theory, higher moments also attracted scholarly attention.

Interestingly, skewness analysis is an important issue in financial theory. Specifically, this issue is related to the literature on stock return predictability. In this literature strand, several studies investigate the role of high moments (particularly skewness) as a determinant of cross-sectional returns, portfolio diversification, and asset allocation, and some of them show that realized skewness has a negative relationship with future returns (Amaya et al., 2015; Chen et al., 2016; Conrad et al., 2013; Harvey and Siddique, 2000). Other studies investigate the role of return asymmetry on portfolio choice (Jiang et al., 2016; Mitton and Vorkink, 2007; Narayan and Ahmed, 2014) and show that skewness improves portfolio efficiency. However, this body of literature is not abundant and is rather inconclusive.

This paper investigates whether it is profitable to invest in emerging markets. In addition to the classical first and second moments used in asset allocation, we focus on the third moment: realized skewness. Interestingly, we add to the literature by studying a large sample of emerging stock markets. Our choice of emerging markets is motivated by the improving integration of international financial markets and development of emerging financial markets, which may constitute an investment alternative for investors. Specifically, we investigate whether investing in emerging markets can be profitable for international and local investors. Our sample covers 22 emerging markets from four regions.

The empirical methodology can be summarized in the three following steps. First, we verify whether the asymmetry effect drives returns in individual emerging markets. To do this, we construct monthly skewness factors (SKFs) based on realized skewness for individual markets. The construction of these factors is in line with previous studies (Amaya et al., 2015). Second, we investigate the opportunities of emerging markets in terms of investment strategies and asset allocation by constructing portfolios based on skewness and market capitalization. We subsequently set five different investing strategies in these portfolios. Finally, the economic gain of our strategies from an asset allocation perspective is measured by considering, in addition to the mean and variance, the fluctuations of the third moment.

Our analysis reveals interesting findings. First, we show that the asymmetry effect drives returns in individual emerging markets. Five markets exhibit a positive SKF and 17 a negative SKF, and this factor is significant for all emerging markets. We also show that the asymmetry factors of 11 individual markets are sensitive to periods of economic and financial turmoil. In other words, crisis periods affect SKF in these markets, which in turn, affects investor positions. From an asset allocation perspective, our results show that the most efficient strategy differs from one region to another, and that skewness-based strategies of investing in emerging markets outperform investing in developed markets (DM) and can generate positive certainty equivalent return (CER) gains, especially during periods of global financial crisis and thereafter. These results are robust to the use of the robust asymmetry measure of Brys, Hubert, and Struyf (2004) and, hence, international emerging markets are recommended as investment avenues over developed markets.

Keywords: emerging markets, realized skewness, investment strategy, diversification opportunities

JEL codes: F21, G12, G15


Eight Asian markets (China, India, Korea, Malaysia, the Philippines, Sri Lanka, Taiwan, and Thailand), four European markets (Czech Republic, Hungary, Poland, and Russia), six Latin American markets (Argentina, Brazil, Chile, Colombia, Mexico, and Peru), and four Middle Eastern and North African (MENA) markets (Egypt, Jordan, Morocco, and Turkey).

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