International equity holdings and stock returns correlations: Does diversification matter at all for portfolio choice?
AbstractDo 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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Date of creation: Jul 2005
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international portfolio choice ; international stock return correlations ; financial integration ; endogeneity bias;
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