Concern

The size of the markets can work against foreign investors in two ways. First, some securities and some countries may be illiquid. In such markets, any reasonably sized trades are sufficient to move the price. The price rises when one wants to buy and falls upon a sale. This is particularly painful because most foreign investors end up selling and buying around the same time.

The second concern with market size is inefficiency. Emerging markets are known to be inefficient, and prices can take several days to fully reflect new information. As a passive investor, you can lose money to more sophisticated investors who trade on the basis of the inefficiency. Read more »

Posted: February 14th, 2008 under Commodities Futures, Future Investing, Future Management.
Comments: 6

Costs and Taxes

Concern

The cost of investing internationally is significantly higher than investing domestically because of many factors. First, gathering information about foreign stocks is more expensive. Foreign companies reveal much less information about their operations than their American counterparts because they do not have the same kind of disclosure requirements. Moreover, the information that is available in the public domain is more difficult to obtain and more expensive. Investors must subscribe to foreign database subscription services, fax services, and foreign newspapers and pay for expedited delivery to obtain the information in a timely manner. And differences in accounting practices mean that financial statements are not easily comparable. These difficulties make research required to value foreign company more expensive and more uncertain. Read more »

Posted: February 14th, 2008 under Future Exchange.
Comments: 3

There are a variety of concerns with international investing and limitations of the analysis cited in previous sections. These limitations are discussed below and may weaken the case for international investing.

Increasing and Varying Correlations

Concern

The key benefit from international investing arises because of low correlations between the domestic market and foreign markets. There are two criticisms of historical correlations. First, the correlations may be increasing due to greater global integration as evidenced by larger capital and trade flows. Moreover, as more and more emerging markets liberalize capital flows, the correlations will increase. If the correlations are increasing, the above analysis based on prior data overestimates the benefit from international investing. Reconsider the example in the preamble of “Evidence,” above. With a correlation of 0.60, the new portfolio’s risk fell from 18 percent to 16 percent. However, if the correlation is 0.70 instead of 0′:60, then the new portfolio’s risk falls less, from 18 percent to 16.6 percent. If the correlation is 0.8, then the risk is 17.1 percent.

You can see that the gains from international investing can quickly erode with an increase in correlations. Read more »

Posted: February 14th, 2008 under Futures Market, Futures Trading System, investment, market.
Comments: 5

Key Points

• When currencies are exchanged for delivery more than two business days later, the governing exchange rate is the forward rate. The forward rate is given by an inviolable interest rate parity that ensures that two riskless investments generate the same total return. Under normal circumstances, the forward rate should be an unbiased predictor of the future spot rate. However, the actual future spot rate is significantly different from the forward rate. This phenomenon is referred to as the forward rate bias.
• In order to satisfy the requirement of the same return generated by two riskless assets given by interest rate parity, the currency with the higher interest rate must depreciate relative to a currency with a lower interest rate as given by the forward rate. Evidence indicates that the currency with the higher interest rate actually appreciates instead of depreciating. This pattern is confirmed for a variety of currency pairs not including high-interest-rate currencies, for many different observation periods, and many different holding periods. It seems that the bias decreased a little during the 1990s and it disappears when the holding period becomes about ten years. However, the bias at short holding periods of about one month is of most interest to investors.

Read more »

Posted: February 14th, 2008 under Currency Futures.
Comments: 4