What Matters in International Equity Diversification?

Posted: 2 Aug 2011

See all articles by Chun-Hung Chen

Chun-Hung Chen

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

David Reich

King County WA

Wenling Lin

Office of Comptroller of Currency

Date Written: July 23, 2011

Abstract

Over the last decade, there has been renewed interest from investors and financial advisors in increasing international equity exposure. Investors confront one of two key issues in making decisions on their strategic allocations, depending on the starting point of their portfolio: (i) for a US-only equity portfolio, the issue is which strategies produce the most beneficial international exposure; (ii) for a portfolio already with significant international exposure, the issue is what benefits are there in exploring small cap, micro cap and new frontiers in international equity investing. We use mean-variance spanning and optimization tests of indexes to assess the comparative benefits of competing paths to international diversification of the equity segment of an investor’s portfolio. We find that for investors with a US-only stock segment in their portfolio, any of the international indexes examined substantially improve risk and return characteristics; more evidence that home bias is costly. There are no clear winners among the indexes, however. For the investor who already has a diversified portfolio of large and small cap US, large cap developed ex-US, and large cap emerging markets, an extension to small cap emerging markets would be beneficial. The additional diversification and return benefits from extending to small and micro cap non-US developed, micro cap emerging, and frontier markets are small.

Keywords: International Diversification, American Depository Receipts, Small-Cap Stocks, Frontier Markets, Emerging Markets, Mean-Variance Spanning, Downside Risk

JEL Classification: G11, G15, G23, C32, C61

Suggested Citation

Chen, Chun-Hung and Reich, David and Lin, Wenling, What Matters in International Equity Diversification? (July 23, 2011). Available at SSRN: https://ssrn.com/abstract=1894346 or http://dx.doi.org/10.2139/ssrn.1894346

Chun-Hung Chen

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street SW
Washington, DC 20219
United States

David Reich

King County WA ( email )

516 Third Avenue
Seattle, WA 98104
United States
+206.205.0988 (Phone)

Wenling Lin (Contact Author)

Office of Comptroller of Currency ( email )

400 7th Street SW
Washington, DC 20219
United States

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