Global Portfolio Diversification for Long-Horizon Investors

57 Pages Posted: 27 Mar 2017 Last revised: 11 Jul 2018

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Zixuan (Kevin) Wang

Harvard Business School

Multiple version iconThere are 2 versions of this paper

Date Written: July 11, 2018

Abstract

This paper conducts a theoretical and empirical investigation of global portfolio diversification for long-horizon investors in the presence of permanent cash flow shocks and transitory discount rate shocks to asset prices and returns. An increase in the cross-country correlations of cash flow shocks raises the risk of a globally diversified portfolio at all horizons. By contrast, an increase in the cross-country correlations of discount rate shocks has a muted effect on portfolio risk at long horizons and does not diminish the benefits of global portfolio diversification to long-term investors. Empirically, we find that increased correlations of discount rate shocks resulting from financial globalization appear to be the main driver of an estimated secular increase in the cross-country correlations of both stock and bond returns since the late 1990’s. Increased correlations of inflation shocks are also an important source of the shift in bond correlations. By contrast, we don’t find evidence of an increase in the cross-country correlations of equity cash flow news or stock market volatility shocks. Our findings imply that the benefits of global equity diversification have not declined for long horizon investors despite the secular increase in global stock correlations, while the benefits of global bond diversification have declined.

JEL Classification: G12

Suggested Citation

Viceira, Luis M. and Wang, Zixuan (Kevin), Global Portfolio Diversification for Long-Horizon Investors (July 11, 2018). Harvard Business School Finance Working Paper No. 17-085. Available at SSRN: https://ssrn.com/abstract=2941652 or http://dx.doi.org/10.2139/ssrn.2941652

Luis M. Viceira (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Zixuan (Kevin) Wang

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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