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International equity holdings and stock returns correlations: Does diversification matter at all for portfolio choice?

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Author Info

  • Nicolas Coeurdacier

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris)

  • Stéphane Guibaud

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris)

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 correlation with past correlation to control for endogeneity, we recover asset demand functions that decrease with return correlation.

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Bibliographic Info

Paper provided by HAL in its series PSE Working Papers with number halshs-00590777.

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Date of creation: Jul 2005
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Handle: RePEc:hal:psewpa:halshs-00590777

Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00590777
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Related research

Keywords: international portfolio choice ; international stock return correlations ; financial integration ; endogeneity bias;

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Cited by:
  1. Barry Eichengreen & Pipat Luengnaruemitchai, 2008. "Bond Markets as Conduits for Capital Flows: How Does Asia Compare?," NBER Chapters, in: International Financial Issues in the Pacific Rim: Global Imbalances, Financial Liberalization, and Exchange Rate Policy (NBER-EASE Volume 17), pages 267-313 National Bureau of Economic Research, Inc.
  2. Philip R. Lane, 2006. "Global Bond Portfolios and EMU," The Institute for International Integration Studies Discussion Paper Series iiisdp168, IIIS.
  3. Yohei Okawa & Eric van Wincoop, 2010. "Gravity in International Finance," Working Papers 072010, Hong Kong Institute for Monetary Research.

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