Modeling the Risk-Return Relationship in the Shares Market for Developed Countries and Emerging Countries within a Partially Integrated World

Abstract

To estimate the risk-return relationship at the global level, we normally start from the assumption of perfect integration. However, the integration process is complex, gradual, and may take several years. This implies that the world is partially integrated and asset pricing models should include variables that recognize a certain degree of segmentation. This study proposes a multi-factor model to relate the return and the risk observed in developed and emerging countries within a partially integrated world. A multiple linear regression analysis was used, which permitted identifying risk measures with higher explanatory power over profit and it was validated through a robust regression. For the developed countries, it was found that systematic risk explains profit to a good measure; nevertheless, for emerging countries it was found that risks due to type of exchange rate and economic instability, coupled with the size of the shares market, explain over 40% of the variation of returns and that systematic risk does not add explanatory powder in these economies