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International Portfolio Diversification Is Better Than You Think

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Do investors completely ignore the basics of portfolio theory? Given their over-exposure on domestic risk, investors should try to hedge this risk by picking foreign assets that have low correlation with their home assets. In the data though, we find a robust positive relationship between bilateral equity holdings and bilateral return correlations. We argue that this finding could be driven by the common impact of financial integration on cross-border equity holdings and on cross-market correlations. Indeed, when we instrument current correlations with past correlations to control for endogeneity, we recover asset demand functions that decrease with returns correlation.

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  • Coeurdacier, Nicolas & Guibaud, Stéphane, 2006. "International Portfolio Diversification Is Better Than You Think," ESSEC Working Papers DR 06013, ESSEC Research Center, ESSEC Business School.
    • Handle: RePEc:ebg:essewp:dr-06013
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    More about this item

    Keywords

    Endogeneity Bias; Financial Integration; International Portfolio Choice; International Stock Return Correlations;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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