Hedges, Safe Havens and Diversifiers for Emerging Markets: The Case of Borsa Istanbul

1. Hedges, Safe Havens and Diversifiers for Emerging Markets: The Case of Borsa Istanbul RızaDemirer Department of Economics & Finance Southern Illinois University Edwardsville 5th Izmir Economic Congress Oct. 30 – Nov. 1, 2013

2. Risks in Emerging Markets • Global financial crises and emerging markets • Challenges in most developing markets • Institutional characteristics: • Underdeveloped investment culture • Underdeveloped institutional investor base • Liquidity issues • Limited risk management instruments available • Regulatory weaknesses • Global factors: • Financial integration and contagion • Role of foreign investors Financial Risk Management in Turkey

3. Turkey – A High BETA Economy? • Reliance on hot money • Share of publicly held stocks dominated by foreign investors Financial Risk Management in Turkey

4. The Case of Borsa Istanbul Financial Risk Management in Turkey

5. The Case of Borsa Istanbul Financial Risk Management in Turkey

6. Risks in Emerging Markets   Market stress Safer assets Currency market Stock market Interest rates • Can foreign traded assets be utilized to manage emerging market risks? • USD denominated risk management instruments: • Gold: A traditional safe haven for bad times • S&P 500: Can help manage country betas • Euro: Can help mitigate negative FX effects • Crude Oil: Economies sensitive to energy prices • CBOE Volatility Index (VIX): Designed to manage volatility • Treasury securities: A possible safe haven? Financial Risk Management in Turkey

7. Hedge, Safe Haven or Diversifier • Hedge: An asset that is uncorrelated or negativelycorrelated with another asset on average. • Might not offset losses during periods of stress • Could be (+)ly correlated during periods of stress • Safe haven: An asset that is uncorrelated or negatively correlated with another asset during periods of market stress. • Might offset losses during periods of stress • Diversifier: An asset that is positively (but not perfectly) correlated with another asset on average. • Might not offset losses during periods of stress Financial Risk Management in Turkey

8. Borsa Istanbul Returns and Global Instruments 2008 global crisis period Financial Risk Management in Turkey

9. Testing Methodology , • Similar to Capie et al. (2005), Baur and Lucey (2010) and Hood and Malik (2013), estimate where • Zero or negative β0 implies that commodity may serve as a hedge for the asset since they are uncorrelated or negatively correlated on average. • Non-positive total effect, i.e. (β0+β1+β2+β3) implies that commodity may serve as a safe haven since they are either uncorrelated or negatively correlated during periods of market stress. Financial Risk Management in Turkey

10. Data • Daily data on • Borsa Istanbul sector indexes for Financials, Industrials, Services, and Technology • Financials, Industrials, Services, and Technology • Financials accounted for 71% of the total traded value by foreign investors (2011 factbook) • Risk management instruments • Futures contracts on S&P 500, Crude Oil, Euro/USD, VIX, Gold, U.S. T-Bonds and U.S. T-Notes. • Sample period covers time series for Jan 4, 2000−Oct. 8, 2013. Financial Risk Management in Turkey

11. Hedge and Safe Haven Assessment Financial Risk Management in Turkey

12. Hedge and Safe Haven Assessment Financial Risk Management in Turkey

13. Hedge and Safe Haven Assessment Financial Risk Management in Turkey

14. Hedge and Safe Haven Assessment • Highly liquid U.S. based futures contracts , with the exception of Crude Oil futures, may serve as hedging instruments to manage the equity market risk in Turkey even after the FX adjustment is made. • Potential safe havens • Euro and VIX futures for Financials • VIX futures for Services • Treasury futures for Industrials Financial Risk Management in Turkey

15. Alternative Risk Measures • The augmented portfolio (AP) is composed of h units of the futures contract for each unit of the asset position in the domestic market. • Alternative risk measures: • Portfolio variance: • Downside risk (expected shortfall given target return T) modeled by the Lower Partial Moment: Financial Risk Management in Turkey

16. Optimal Positions and Risk Reduction Financial Risk Management in Turkey

17. Optimal Positions and Risk Reduction Financial Risk Management in Turkey

18. In sample risk-adjusted performance Financial Risk Management in Turkey

19. Out-of-sample risk-adjusted performance Financial Risk Management in Turkey

20. Out-of-sample risk-adjusted performance BIST Gold hedged Financial Risk Management in Turkey

21. Conclusions • Hedges & Safe Havens - Highly liquid U.S. based futures contracts may serve as hedging instruments even after FX adjustment • Significant amount of market risk can be eliminated • May help mitigate the negative FX volatility effects • Reduces cost of capital for firms that use appropriate portfolio-specific hedging strategies • Euro and Treasury futures provide the greatest risk reduction potential • May also serve as safe havens depending on the portfolio’s focus Financial Risk Management in Turkey

22. Conclusions • Diversifiers - Risk minimization strategies using foreign traded assets also lead to favorable risk adjusted returns for investors in these markets • Investors can utilize these assets in order to achieve better risk-return tradeoffs in their portfolios. • Euro and Treasury futures with the best out-of-sample performance • However, they should primarily seek to minimize downside risk as an investment strategy. • For policy makers: • More hedging instruments must be offered to manage market risks, particularly global risk factors. • For market makers: • Potential market exists for products mimicking the performance of Euro, Treasury securities and VIX. Financial Risk Management in Turkey