Does Sector Diversification Benefit All Markets?-Analysis of Australian and Indian Markets

Abstract

With the integration of global markets, the opportunities of benefiting from international diversification are diminishing and investors from developed countries are looking at the emerging markets to gain from lower correlations of emerging markets with those of the developed markets. In view of increasing correlations of emerging markets with developed markets and higher transaction costs, sector diversification within the domestic markets provides a good alternative to international diversification. Two markets, each at a different stage of development, are tested in this study, and benefits are found in allocating an investment portfolio across sectors in both markets. This study uses an asymmetric Dynamic Conditional Correlation (DCC) GARCH model for an accurate estimate of correlations and tests the benefits of diversification using two models of performance measurement. The robustness of the results is tested using different restrictions on portfolios. An out-of-sample analysis shows portfolios with fewer restrictions provide superior results as compared with highly restricted portfolios.