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International Portfolio Diversification Is Better Than You Think

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  • Coeurdacier, Nicolas

    ()
    (ESSEC Business School)

  • Guibaud, Stéphane

    ()
    (London School of Economics and Political Science, Department of Finance)

Abstract

Do investors completely ignore the basics of portfolio theory? Given their over-exposure on domestic risk, investors should try to hedge this risk by picking foreign assets that have low correlation with their home assets. In the data though, we find a robust positive relationship between bilateral equity holdings and bilateral return correlations. We argue that this finding could be driven by the common impact of financial integration on cross-border equity holdings and on cross-market correlations. Indeed, when we instrument current correlations with past correlations to control for endogeneity, we recover asset demand functions that decrease with returns correlation.

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Bibliographic Info

Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 06013.

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Length: 30 pages
Date of creation: Oct 2006
Date of revision:
Handle: RePEc:ebg:essewp:dr-06013

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Web page: http://www.essec.edu/
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Keywords: Endogeneity Bias; Financial Integration; International Portfolio Choice; International Stock Return Correlations;

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Cited by:
  1. Rudiger Ahrend & Antoine Goujard, 2012. "International Capital Mobility and Financial Fragility - Part 6. Are all Forms of Financial Integration Equally Risky in Times of Financial Turmoil?: Asset Price Contagion During the Global Financial ," OECD Economics Department Working Papers 969, OECD Publishing.
  2. Marta Arespa, 2011. "A New Open Economy Macroeconomic Model with Endogenous Portfolio Diversifi cation and Firms Entry," Working Papers XREAP2011-15, Xarxa de Referència en Economia Aplicada (XREAP), revised Oct 2011.
  3. Pierucci, Eleonora & Pericoli, Filippo & Ventura, Luigi, 2014. "Reassessing international investment patterns: a revisitation of Lane and Milesi-Ferretti's evidence," MPRA Paper 53585, University Library of Munich, Germany.
  4. Pericoli, F.M. & Pierucci, E. & Ventura, L., 2013. "Cross-border equity portfolio choices and the diversification motive: A fractional regression approach," Economics Letters, Elsevier, vol. 121(2), pages 282-286.
  5. Okawa, Yohei & van Wincoop, Eric, 2012. "Gravity in International Finance," Journal of International Economics, Elsevier, vol. 87(2), pages 205-215.
  6. Robert Vermeulen, 2011. "International Diversification During the Financial Crisis: A Blessing for Equity Investors?," DNB Working Papers 324, Netherlands Central Bank, Research Department.
  7. Edyta Stepien & Yuli Su, 2012. "International portfolios and currency hedging: viewpoint of Polish investors," Managerial Finance, Emerald Group Publishing, vol. 38(7), pages 660-677.

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