Numeraire Portfolio Tests of the Size and Source of Gains from International Diversification
38 Pages Posted: 25 Nov 2002
Date Written: October 29, 2002
We measure the size and sources of gains from international diversification using metrics that are independent of currency choices. When we apply these measures to industry sector portfolios for six large equity markets, we find that, offered costless access to a foreign market, investors would construct portfolios with substantial leverage to obtain large certainty-equivalent wealth gains from that market access. At the same time, modest proportional transaction costs would eliminate all of these gains by inducing investors to voluntarily forego positions in foreign assets. Using the same measures, we find that emerging market equity indices offer fewer gains from diversification than assets from developed markets.
Keywords: Gains from international diversification, international market integration, numeraire portfolio, stochastic discount factor
JEL Classification: G12, F36, G15
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