What is a World Economy? How about Investing in World Economy?

A World Economy is the sum total of all the economies of all the countries of world, including the manner they interact among themselves. In short, it is a family of members with each having different capabilities and risks. The exotic concept of World economy has arisen because of high reliance on Globalization. This globalization has created links between different individual elements (an element is a economy of a particular nation) of the world and because of this link, our activities are reflected to the outside world in few minutes or seconds after the act.


Why do people Invest?

They do because:

Investments has brought extreme fortune for many rich individuals including Warren Buffet and George Soros across the world economies. And because of the possibility of making money in short term and long term, investors are mesmerized by the concept of investing. But we shouldn't forget that although every investor has two common objectives of managing returns and managing risks, however, Investing for individuals is as different as they themselves are. Investors have different needs for liquidity (governed by High priority short term & long term goals, the presence of credit facility in a country, bid - ask spreads in that particular issue, internal efficiency of Stocks, Bonds, Futures and options Exchanges in executing transactions, age and level of emotion stability, current and expected future incomes including risk measures of Inflation & Interest rates etc.), Risk Tolerance (Age, financial stability etc.) and most importantly, Return expectations.

Is Globalization an Advantage or Disadvantage to Investing ?

As mentioned previously, Investing is not just managing returns, it is more than that. It's managing risk attached with earning those risks. With the developments of new Financial Products, Global investing has become much more easier than it was 15 - 20 years back. The power of computing has reduced the transactions costs and reduced costs have caused people to spread their wings in world economy for investing. For example: With global Exchange Traded Funds (ETF's), an investor can establish both long or short position (long = Buy, Short = Sell) covering the entire global markets by purchasing just a single instrument. Thus full diversification is available.

However, how much of a good thing can you have? Previously portfolio managers have included the foreign stocks, bonds etc in their portfolios on account of lower correlation among the assets in US and other foreign nations. But, because of this excessive globalization, the world economies are becoming more integrated and business cycles of individual economies are getting synchronized and thereby the correlation among foreign and US assets are rising. How do we define risks, after all? Can we quantify risks? Yes, we can. The quantification of risks was first propounded by Harry Markowitz in Modern Portfolio theory. MPT describes how risk averse investors will diversify to attain optimal portfolio. Mr. Markowitz suggested that investors view variability of expected returns as risks and from thereon, the Variance and Standard deviation has been used to quantify risks. He also developed a formula for calculating variance, where in he charted out the importance of Covariance and Correlation between two assets. He proved that as we go on increasing the number of securities in the portfolio, it is the average covariance between the assets that matters the most and not the individual standard deviation of the assets.
Based on the work of Mr. Markowitz and the globalization of the world economies, it can be said that correlation between domestic and foreign securities is rising and thus the benefit of diversification by including foreign assets in your domestic securities portfolio, the benefit of diversification is going down.

But on other hand, we can argue that due to intense globalization and intense computing power, the transaction costs have fallen tremendously. So to some extent, the lost benefits from international diversification has been offset by a fall in costs of ordering and executing trades.