“Allocations should be made to markets where there is an expected increase in global integration, and reductions should be made in markets that are already highly integrated.”
Is this statement true or false and can you explain the theory and logic behind it. Understand it has to with how integrated a market is.
Its true. If you increase allocation to a market whose integration with global market will increase, the risk premium (recall Singer-Terhaar) will start falling, leading to a lower discount rate and an increase in value.
OP I think you might be overthinking it. The general assumption is greater market integration leads to higher returns and vice versa.
It’s true.
Through Singer-Terhaar, we calculate the global market risk premium first (along with the assets beta), and then we calculate the individual assets risk premium. The idea of the integration is that we are adding on an additional individual market risk premium to the global risk premium we will already be exposed to. Therefore, if the market is fully segmented, it adds additional risk into the portfolio that isn’t accounted for in the global market portfolio. In contrast, the integrated market will already be somewhat accounted for in the global market risk premium.
Think about the final term of the Integration formula : RP(individual market) = (Integration * integrated market Risk Premium) + ((1-Integration) segmented market risk premium))*. As ‘integration’ grows, so does the additional risk contribution from the segmented market risk premium.
Hopefully, this helps.