Cross-Listings and Liquidity Risk Diversification
44 Pages Posted: 21 Jan 2015 Last revised: 7 Nov 2015
Date Written: November 6, 2015
Recent studies document the diminishing benefits from international diversification, especially for large-cap stocks and in developed markets. This paper evaluates the potential diversification benefits of holding cross-listed stocks from a liquidity risk perspective. By examining the dependence structure between the U.S. market portfolio and cross-listings from 1950 to 2012, this study finds that the average linear correlation, rank correlation, and tail dependence of liquidity innovations are notably lower than those of portfolio returns. Unlike the portfolio returns, there is no evidence of an upward trend in the correlation of liquidity innovations. The subsequent portfolio mimicking test reveals that the liquidity innovations of cross-listings cannot be spanned by U.S. size and industry portfolios. The solution of the portfolio optimization problem under the Mean-Variance-Liquidity framework shows that holding foreign listings in the U.S. can reduce the liquidity risk by up to 40 percent for U.S domestic investors. My findings suggest the benefits of international diversification are especially profound in the dimension of liquidity risk.
Keywords: Asset allocation, Copula, Dynamic conditional correlation, Mean-variance spanning
JEL Classification: F65, G11, G15
Suggested Citation: Suggested Citation