Testing for Mean-Variance Spanning with Short Sales Constraints and Transaction Costs: The Case of Emerging Markets


  • Frans A. De Roon,

  • Theo E. Nijman,

  • Bas J. M. Werker

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    • De Roon is from Erasmus University Rotterdam and CEPR, Nijman and Werker are from Tilburg University. Geert Bekaert, Feico Drost, Bruno Gerard, Pierre Hillion, Erzo Luttmer, Bertrand Melenberg, Rene Stulz (the editor), and an anonymous referee have provided many helpful comments and suggestions. We are also grateful to comments made by participants of the 1997 EFA meetings in Vienna and the 1998 AFA meetings in Chicago, and by seminar participants at INSEAD, the Norwegian School of Management, and the Stockholm School of Economics. The last author thanks the Humbold Universität zu Berlin for its hospitality during a time when part of this research was carried out.


We propose regression-based tests for mean-variance spanning in the case where investors face market frictions such as short sales constraints and transaction costs. We test whether U.S. investors can extend their efficient set by investing in emerging markets when accounting for such frictions. For the period after the major liberalizations in the emerging markets, we find strong evidence for diversification benefits when market frictions are excluded, but this evidence disappears when investors face short sales constraints or small transaction costs. Although simulations suggest that there is a possible small-sample bias, this bias appears to be too small to affect our conclusions.