Equity Markets and Economic Development: What Do We Know

E(Ri / Ωt-1 )- r =δt-COV(θ,-1 * R_v, Rw /Ωt-1 )

E(Ri /Ωt-1 )-r, = δ,-C∙θt-1 * VAR(Rw_l IΩ,.,)

(4)

Letting i be the domestic portfolio, domestic excess returns can be expressed as follows:

E(R IΩt-1)-r, = δ,-1 *COV(Ri,RwIΩ,-1 )

(5)

It follows that the expected gains from international diversification are equal to:

E(R -RiIΩ,-1 ) = δ,-1 *∣θ,-1 * VAR(Rw,,1Ωt-1 )]-COV(Ri,Rw,IΩ_r-1 )

(6)

Considering the conditional correlation coefficient between the domestic and the global

portfolio p_iz,t-1

COV(Ri,Rw,IΩ J ;

VVRR(Ri,, IΩ,-1 )* VAR(Rw, IΩ,-1 ) ’

it can be shown that:

θT-1*VAR(Rw,tIΩt-1)-COV(Ri,RwIΩT-1)=(1-pi,w,t-1)*VAR(Ri,tIΩt-1)                   (7)

And by substitution:

^E(^Ri ^-Ri^IΩT-1)^=δT-1 ^*(^1-pi,w,t-1)^*VAR(^Ri,t^Ωt-1)

(8)