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Investing on the Edge: exploring the Opportunities for Diversification in Frontier Markets

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Abstract

The increase in the degree of integration of emerging stock markets with the mature markets together with rising correlations among asset classes have posed new challenges to investors in their quest for diversification opportunities. Frontier markets have risen up to the challenge, opening avenues for greater diversification benefits compared to their emerging counterparts. This study attempts to shed light on how the characteristics of frontier markets can enable investors to reap greater benefits from portfolio diversification. To this end, we examine the extent of integration of fifteen Central and Eastern European (CEE) and Middle Eastern and North African (MENA) frontier markets, both with mature markets and within their own group, over the period from Dec. 2005 to May 2015. For this purpose, we employ correlation and cointegration techniques to assess both short- and long-run comovements. The results suggest a greater degree of integration at the regional level. At the global level, the selected CEE frontier markets are more closely linked with their developed counterparts than the MENA frontier markets considered, suggesting that the MENA markets may have greater potential for diversification gains.