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International portfolio diversification is better than you think

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  • Nicolas Coeurdacier

    (Département d'économie)

  • Stéphane Guibaud

    (Department of Finance)

Abstract

Using aggregate data on bilateral cross-border equity holdings, we investigate whether investors correctly hedge their over-exposure to domestic risk (the well-known equity home bias) by investing in foreign stock markets that have low correlation with their home stock market. To deal with the endogeneity of stock return correlations, we instrument current correlations with past correlations. Controlling for many determinants of international portfolios, we find that, all else equal, investors do tilt their foreign holdings towards countries, which offer better diversification opportunities. The diversification motive that we uncover is stronger for source countries exhibiting a higher level of home bias.

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Paper provided by Sciences Po in its series Sciences Po publications with number info:hdl:2441/c8dmi8nm4pdjkuc9g70969520.

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Date of creation: Mar 2011
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Publication status: Published in Journal of International Money and Finance, 2011, vol. 30, pp.289-308
Handle: RePEc:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g70969520

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Keywords: International Portfolio Choice; Bilateral Equity Holdings; Portfolio Diversi¯ca- tion; International Stock Return Correlations; Financial Integration; Endogeneity Bias;

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Cited by:
  1. Okawa, Yohei & van Wincoop, Eric, 2012. "Gravity in International Finance," Journal of International Economics, Elsevier, vol. 87(2), pages 205-215.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. Vermeulen, Robert, 2013. "International diversification during the financial crisis: A blessing for equity investors?," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 104-123.

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