Equity Markets, Valuation, and Analysis

CHAPTER 22Investing in Emerging Markets

Xiaohua Diao

Professor of Finance, Chongqing Technology and Business University

Shantanu Dutta

Associate Professor of Finance, University of Ottawa

Peng Cheng Zhu

Associate Professor of Finance, University of San Diego

INTRODUCTION

Traditionally, emerging markets have offered both greater return potential and diversification opportunities than do purely domestic investments (Conover 2011). Since developed markets' asset returns show an increased level of co-movement over the years, investors have fewer opportunities to diversify their risks if they focus only on developed markets, making emerging markets particularly appealing to global investors. Although recent evidence shows that emerging market returns are converging to those of developed markets, Goetzmann, Li, and Rouwenhorst (2005) and Eun and Lee (2010) contend that emerging markets are still distinct from developed markets and provide a greater opportunity to invest in an expanded number of markets and diversify investment risk.

Although a large gap still remains between emerging markets' gross domestic product (GDP) share in the world and their market capitalization, this gap has decreased in recent decades. For example, in 1987, emerging market GDP represented only 16 percent of world GDP and less than 1 percent of world market capitalization. By 2016, these figures had changed to 40 percent of world GDP and 10.8 percent of world market capitalization (Bekaert and Harvey