International equity portfolio allocations and transaction costs

I got an email out of the blue.

Dear Dr. Bhaskar,

Hope this email finds you in best of your health and spirit.

I am Chandra, Sunil Poshakwale’s PhD student and you were one of my external advisors in my MRes. I would like to thank you for all your help and support at the initial stage of my PhD. I have now completed my doctorate and working as a Lecturer at the University of Stirling, Scotland. In fact you were the one to float my doctorate’s idea when you visited Cranfield University as a guest lecturer in 2007. I still remember you saying to me that one of the reasons you do not trade in emerging markets because its not worth it, given the high transaction cost. You then asked me to prove this, if I could and that would be a good PhD project.

Tapping your idea of transaction costs I have now published a paper in Journal of Banking and Finance. Please find attached the article which I published with Sunil.

Once again profound thanks for all your support. I would be very glad to have further research ideas which I can work on, pariticulary those benefiting international investors.

Kind regards

Dr. Chandra Thapa
Lecturer in Finance
University of Stirling
Stirling
FK9 4LA
Scotland
UK
Webpage:http://www.management.stir.ac.uk/people/accounting-and-finance/academic-staff/chandra-thapa
--

Quite a nice man, eh? for him to remember an off the cuff conversation from many years back. This is the paper he has written along with my old friend Sunil Poskakwale. Journal of Banking & Finance 34 (2010) 2627–2638

a b s t r a c t
In spite of the critical role of transaction cost, there are not many papers that explicitly examine its influence
on international equity portfolio allocation decisions. Using bilateral cross-country equity portfolio
investment data and three direct measures of transaction costs for 36 countries, we provide evidence that
markets where transaction costs are lower attract greater equity portfolio investments. The results imply
that future research on international equity portfolio diversification cannot afford to ignore the role of
transaction costs, and policy makers, especially in emerging markets, will have to reduce transaction
costs to attract higher levels of foreign equity portfolio investments.

Interesting article indeed and something that does touch on one of my pet bug bears, the assumption that transaction costs are zero. This is ridiculous to assume that they are zero. They arent zero, this isnt a perfect world. Economics and Finance are applied sciences, what’s the bloody point of putting in an assumption like that? Next thing you know, you will assume that investors are totally rational and follow all economic laws. heh.