Essays on Interaction Among Asset Returns and Diversification Benefits

The recent financial crisis associated with the collapse of the US housing market led to a drastic decline in the stock market and in securitized real estate indices. On the other hand, the price of US Treasury bonds moved up for a short span of time. The first chapter investigates the links and trade-offs among several assets such as stocks, bonds, securitized and residential real estate. It also examines periods in which time deposits offer the best investment opportunity given the market risk-return. Structural vector autoregressive models (SVAR) are used to study the role of residential real estate risk in explaining the relationship among these asset returns. Some interesting results are revealed by the analysis, which sheds light on investors' portfolio diversification and asset allocation decisions. Among other results, the paper finds a 'flight to safety' phenomenon, whereby a rise in real estate risk induces investors to move from risky assets (stocks, securitized and residential real estate) to safer markets (bonds and time-deposits).;During the recent global financial, various assets witness extreme movements---US and emerging nations' stock (BRIC) indices suffered drastic decline; price of gold and US bonds witnessed consistent upward trend; and extreme upward movement in oil prices in the beginning of crisis, followed by extreme decline in oil prices in later stage of crisis. These movements indicate some linkages among asset returns. In the second chapter, we attempt to decipher such links or trade-off among asset returns. We attempt to investigate the role of risk and uncertainty from financial markets in explaining pair-wise relationships between two asset returns by using structural vector autoregressive (SVAR). During the periods of the rise in default risk in financial markets, gold and bonds act as safe-haven, but this property of gold is extremely short-lived. The returns on BRIC stocks generally respond similar to US stocks in response to the rise in risk or uncertainty from US financial markets, indicating minimum diversification benefits from BRIC stocks during periods of high risk or uncertainty in US financial markets. Oil also does not provide diversification benefits against US stocks during high financial risk and high uncertainty environment.