Estimating Integration in the Singer–Terhaar Risk Premium Model

Summary

This document outlines the Singer–Terhaar model’s use of a weighted average between an integrated-market risk premium and an isolated-market risk premium. The integrated estimate relates an asset’s premium to its correlation and volatility relative to the global investable market, scaled by the global market’s Sharpe ratio. The isolated estimate drops the correlation term. An integration parameter weights these two boundary cases, but the question asks how that parameter should be estimated.

The answer reports that the original paper treats the two cases as bounds without explaining how to estimate the weight. It also mentions a curriculum example suggesting developed-market bonds and equities are largely integrated, while noting that the cited source is absent. Thus, the document explains the model’s structure and the uncertainty around parameter estimation, but supplies no estimation procedure or empirical validation. Practitioners would need an independently justified assumption or evidence before assigning a specific integration weight.

Key ideas

• Singer–Terhaar combines integrated and isolated market risk premium estimates using an integration weight.
• The integrated premium uses correlation with the global market, asset volatility, and the global market Sharpe ratio.
• The isolated estimate is described as omitting the correlation term.
• The cited discussion does not provide a method for estimating the integration parameter.
• A curriculum example gives an integration figure for developed markets without citing its source.

Tags

# How to estimate market integration parameter in Singer-Terhaar model for E(r)?


# How to estimate market integration parameter in Singer-Terhaar model for E(r)?












Singer-Terhaar is part of CFA II and III curriculum. It estimates risk premium for some asset, traded at some local market, as weighted average of expected premiums for the case of (1) local market, completely integrated with global, and (2) local market completely isolated from global.

For integrated case, risk premium (RP) for asset i

$$ RP_i = \rho_{i,M} \times \sigma_i \times (RP_M/\sigma_M) $$ ,i.e. correlation of asset with global investable market times deviation times GIM's Sharpe ratio. For isolated case CFA recommends just dropping rho term from the formula above.

Weighting parameter ("integration") is then used to multiply to integrated estimate, and to sum with (1-weighting_parameter) times isolated estimate.

The question is: how to estimate integration?

## Answer by BlueTrin (score 2)

https://quant.stackexchange.com/a/16816

Singer and Terhaar original paper can be found at this link. They do not provide an explanation about how to estimate this factor and just mention that both values provide a boundary.

The CFA curriculum mentions that " For example, it has been observed that developed market bonds & equities are approx 80% integrated and 20% segmented.", however the source was not cited.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.