International Portfolio Diversification: Currency, Industry and Country Effects Revisited
44 Pages Posted: 31 Mar 2002 Last revised: 7 Jan 2010
Date Written: December 2009
We examine the relative importance of country, industry, world market and currency risk factors for international stock returns. Our approach focuses on testing the mean-variance efficiency of the various factor portfolios. An unconditional analysis does not detect significant differences between country, industry and world portfolios, nor any role for currency risk factors. However, when we allow expected returns, volatilities and correlations to vary over time, we find that equity returns are mainly driven by global industry and currency risk factors. We propose a novel test to evaluate the relative benefits of alternative investment strategies and find that including currencies is critical to take full advantage of the diversification benefits afforded by international markets.
Keywords: International financial markets, currency risk, mean-variance efficiency, conditioning information
JEL Classification: G11, G15
Suggested Citation: Suggested Citation