International equity portfolio diversification: a sectoral and security-by-security analysis

International portfolio diversification has been shown to be subject to several puzzles, notably the home bias in equity investment, and the correlation bias. Taken together, those facts suggest that not only do investors tend to prefer domestic equity to foreign equity, but that, when they venture into cross-border investments, they do so in countries where stock prices are most correlated with home markets - contradicting the intuition that international investments are used to diversify portfolios more optimally. Our paper deals mainly with the correlation bias. It uses a dataset on French external financial portfolio positions produced by the Banque de France that allows a security-by-security analysis of international positions. We show that although insurance companies and investment funds are indeed more exposed to highly correlated markets, the way they arrange their portfolios at the security-level is consistent with the existence of a diversification motive.