Is Country Diversification Better than Industry Diversification?

22 Pages Posted: 19 May 2006

See all articles by Kent Hargis

Kent Hargis

Bernstein Investment Research and Management

Jianping Mei

New York University (NYU) - Department of Finance

Abstract

In this paper, we develop a framework in which one can examine the source of industry and country diversification by examining their underlying return components. We find that the global cash flow factor explains on average 39% of the variation of country cash flows and global discount rates explain 55% of the variation of country discount rates. These are much less than the explanatory power of the two factors over industry cash flow and discount rate variations, which are 72% and 78% respectively. This suggests that global factors are much less important for return components at country level than at the industry level. As a result, both better diversification of expected returns and cash flows across countries determine the larger benefits of country diversification versus industry diversification. Moreover, emerging markets tend to have much smaller comovements of both dividends and expected returns with those of the world, suggesting a lower degree of integration with the world goods and financial markets. Our results cast doubt on the prevailing wisdom that country diversification should be replaced by industry diversification.

Suggested Citation

Hargis, Kent and Mei, Jianping, Is Country Diversification Better than Industry Diversification?. European Financial Management, Vol. 12, No. 3, pp. 319-340, June 2006. Available at SSRN: https://ssrn.com/abstract=903198 or http://dx.doi.org/10.1111/j.1354-7798.2006.00323.x

Kent Hargis (Contact Author)

Bernstein Investment Research and Management ( email )

1345 Avenue of the Americas
New York, NY 10105
United States

Jianping Mei

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0354 (Phone)
212-995-4221 (Fax)

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