Description:
Frontier markets are considered a good destination for international diversification due to their low level of integration with global markets. However, a diversification strategy into frontier markets with respect to country factors does not optimally capture their full diversification potential. Enhancing this strategy by simultaneously incorporating industry factors improves the ability to diversify portfolio risk. We replicate the Fama and French's (1997) US analysis for industries in frontier markets to investigate the costs of equity of 10 industry portfolios, using five asset pricing models. Additionally, for evidence on industry integration, we examine how well the explanatory factors of developed and emerging markets can explain industry returns. Our results show that eight industries in frontier markets do not exhibit asset pricing integration with developed markets, and five industries do not exhibit asset pricing integration with emerging markets. In line with previous studies, the industry costs of equity in frontier markets are imprecise. However, we document the limited temporal variation of risk loadings, indicating more precise estimates than US, UK, and European ones. Finally, the study provides evidence that the conditional capital asset pricing model and the rolling Fama–French three-factor model could be of interest to fund managers and regulators