Diversification in Euro Area Stock Markets: Country vs. Industry

Abstract

The harmonization of fiscal and economic policy within the European Monetary Union (EMU) has had a considerable impact on the economies of member countries. In particular, several studies indicate that the proceeding economic integration among euro area countries has important consequences for the factors driving asset returns in financial markets. However, these studies rely on one specific methodology (Heston and Rouwenhorst, 1994, 1995), that has recently been critized as too restrictive. This study adopts a mean-variance approach instead. Using recent euro area stock markets data, we find strong evidence that diversification over industries yields more efficient portfolios than diversification over countries.

Keywords: EMU, euro area stock markets, portfolio diversification, industry factors, country factors, European integration process

JEL Classification: G11, G15