Frontier Stock Markets: Local versus Global Factors

Abstract

Examining the frontier markets in the regions of Europe, Africa, Middle East, and Asia by using factor-mimicking portfolios based on market capitalization (SMB), book-to-market equity (HML), and momentum (WML), this study reveals significant returns to value and momentum for all size groups. Local asset pricing models that use locally derived factors and global asset pricing models that use globally derived factors are rejected in nearly all cases. Although local SMB, HML, and WML demonstrate some ability to explain average frontier portfolio returns, global SMB, HML, and WML show no such ability. The evidence suggests that frontier and developed markets are segmented.

TOPICS: Frontier markets, factor-based models, portfolio theory, portfolio construction

Key Findings

• • Local factors perform better than global factors in explaining average frontier market portfolio returns.

• • Frontier and developed markets are segmented.

• • Significant momentum and value cross-sectional return patterns are observed in frontier markets.