Long-run and short-run dynamics between foreign exchange and stock markets: Evidence from Thailand and the Philippines

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Book Chapter

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Accounting and Finance


Since different portfolio managers offer portfolios with different characteristics, evaluating their absolute and relative performance becomes important. In particular, when analyzing the performance of a broad-based mutual fund that tracks a market index such as the Standard & Poor's (S&P) 500, it is imperative to examine whether the fund has done “better” than the existing index and other broad-based mutual funds. This analysis involves comparing the realized (actual) return and risk of the fund to that of other indices and funds. Different performance measures entail different ways of comparing performance. Some focus on the excess return—return realized in excess of what is required commensurate with the risk—obtained by the fund, while others focus on the ratio of the risk premium—return in excess of risk-free rate—to risk. Then again, while some take risk to be total risk, others take it to be the nondiversifiable risk (or what some call beta risk). There are also differences here in that, while some use variance-based risk measures, others measure risk through some downside risk measures such as the semivariance or lower partial moment (LPM). The advantage of the LPM-based measures is that they are valid for all kinds of distributions of returns, while variance-based measures are valid only for spherically symmetric distributions such as the normal distribution. Modigliani and Modigliani 1997 have developed a relatively novel approach for portfolio evaluation, whereby by combining the risk-free asset with the fund to be evaluated, a new portfolio is created whose risk is the same as that of the benchmark or index to which it is being compared. This approach, which takes standard deviation as the measure of risk, allows them to compare just the return (or the risk premium) of the new portfolio with that of the benchmark. But in the newer mean-equivalence approach of Mishra and Rahman, the risk-free asset is combined with the portfolio under consideration to create a pseudo-portfolio whose return is the same as that of the benchmark. Thus, besides allowing one to compare only the risk of the pseudo-portfolio to that of the benchmark, this approach also permits taking different risk measures for the purpose, including weighted averages of total and nondiversifiable risk.

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