Singer-Terhaar market segmentation q expected, familiar, partially

random_walker47

Greetings boys and girls. lovely friday night in nyc, eerily familiar feeling of being UTTERLY LEFT OUT of all living things in the universe… sigh.
here is my question.
under Singer-Terhaar, for segmented markets, we assume the correlation of a market w. the GIM = 1. why is that? shouldn’t it be zero???
To figure out the E(Rm) for a partially integrated market A, we take a weighted average of the expected returns under full integration v. full segmentation, as follows:
1) 100% integrated: using the correlation of market A w. GIM s.t. E(RP) = correlation factor x st dev of market A x GIM Sharpe and
2) 100% segmented: using assumed correlation factor of 1 = st dev market A x GIM Sharpe
but that doesn’t make sense! if the market is fully segmented, shouldn’t its correlation w. GIM Sharpe be zero, not 1?
can anyone please explain?

former

The index that you are measuring correlation with is the local market index in the case of segmented markets (the “global” portfolio is really just the local market portfolio). The reason the correlation is 1 is because there is no impact from other markets, as it is fully segmented.
It doesn’t explicitly state it for the integrated markets, but i would have to think the global portfolio is actually a true global portfolio, when you calculate integrated market equity risk premia.
I think you are comparing two different benchmarks, local market for segmented, global market for integrated.

bluejazzy

When segmented there is ONE market. You are comparing the market to itself. The correlation of any market to itself is 1.
Does that make sense to you ?

onelife1

I think, they should have used another word for this. In the whole field of finance, including discussions on emerging markets investing etc., “segmented” is just a proxy for low correlation.

bigredhockey55

I had trouble with this too. Like MarkCFAIL’S explanation as the market portfolio now being the local market. thanks and moving on.

ba736

I, too, like the explanation that when dealing with segmented market, we have correlation of 1 because we’re measuring against local market.
Problem with this is that in all the questions i’ve seen we are only given one GIM Sharpe, and we use the same GIM Sharpe in BOTH of the components that we weight
when we take a weighted average of the expected returns under full integration v. full segmentation
see, the Schweser example on page 93 in SS6
and yes, would be happy to work on the zoya-jbaphna update!

sabre

I would assume that this is a simplifying assumption made by the CFAI. Lot of information to cover.

Dapper425

Zoya, I did notice this when I reviewed the Schweser and almost mentioned it last night but I was tired and wanted to just move on. It is the only piece of the puzzle that doesn’t add up, and I wasn’t sure if the error was particular to Schweser but you mention it is in the curriculum the same way (same sharpe for both) above, right?
Unfortunately I think we are just going to have to think inside of the box the CFAI wants us to think inside of, for these problems. As a matter of logic, I agree that it makes no sense to imply the sharpe ratio is the same (which implies the global portfolio is the same, or its an awful big coincidence that the local and global are the same sharpe).

Halawiz

GIM, as its name suggests, is the global market. Hence, whether your particular market is segmented or integrated should not make a big difference in the GIM Sharpe Ratio, I think. This especially hold if the market in question is an emerging market. I think this is why they did not mention that issue.

Roflnadal

Mark
Both the Schweser and CFAI treatment are the same: the same GIM Sharpe is used for both integrated and segmented calculations.
I guess I too will just accept this and move on, but one WOULD think that a “perfectly” segmented portfolio would have a correlation of 1 ONLY to the local segmented market, and NOT to the GIM Sharpe.