Numeraire Portfolio Tests of the Size and Source of Gains from International Diversification

38 Pages Posted: 25 Nov 2002

See all articles by Ludger Hentschel

Ludger Hentschel

Alternative Risk Premia Investments

John B. Long

Simon Graduate School of Business, University of Rochester

Date Written: October 29, 2002

Abstract

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

Suggested Citation

Hentschel, Ludger and Long, John B., Numeraire Portfolio Tests of the Size and Source of Gains from International Diversification (October 29, 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=342660 or http://dx.doi.org/10.2139/ssrn.342660

Ludger Hentschel (Contact Author)

Alternative Risk Premia Investments ( email )

1120 Avenue of the Americas
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New York, NY 10036
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HOME PAGE: http://www.ludgerhentschel.com

John B. Long

Simon Graduate School of Business, University of Rochester ( email )

Carol Simon Hall 3-208
Rochester, NY 14627
United States
585-275-3358 (Phone)

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