Are the Gains from Foreign Diversification Diminishing? Assessing teh Impact with Cross-Listed Stocks
AbstractForeign diversification has a long history in financial economics. In this paper, we re-examine this issue with foreign companies that are listed on US exchanges, combining features of three different literatures. One literature suggests that domestic portfolios including cross-listed stocks can duplicate the behavior of foreign market returns without the need for US investors to go abroad. A second literature finds that the returns from these foreign stocks often become more sensitive to the US market after cross-listing. Third, the emerging market on literature finds evidence that the relationships across stock markets shift after stock market liberalizations. In this paper, we combine aspects of these three literatures to assess the impact on foreign diversification with cross-listed firms for a US investor. For this purpose, we use the Bai and Perron (1998) break date estimator to test for and estimate breaks in the sensitivity of individual foreign stocks listed on the NYSE and NASDAQ. We find that returns on foreign stocks have become more sensitive to the US market both directly through their company US betas and indirectly through their home market betas against the US market. As a result, the minimum variance allocation into a portfolio of these companies declines over time. During the financial crises of the late 2000s, investment in foreign company stocks reduce risk only if these stocks can be shorted.
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Bibliographic InfoPaper provided by University of Pennsylvania, Wharton School, Weiss Center in its series Working Papers with number 10-1.
Date of creation: Feb 2010
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