Investing in relative market positions in interconnected financial markets: A strategy for international portfolio diversification

International investors face challenges in properly diversifying their portfolios risk due to the increasingly interconnected nature of financial markets. Using the Tail-Event Driven Network (TENET) model, this study proposes two new indices, relative dominance and relative importance, to measure the relative market position of a stock market in the global stock market network. This study further proposes a dominance-importance-oriented (DIO) strategy to diversify portfolio risk in interconnected stock markets using data from the stock markets of 35 economies. The empirical findings show that stock markets in developed countries generally have higher relative dominance and lower relative importance, whereas those in developing and emerging countries have the opposite pattern. Moreover, financial liberalization is an important determinant of stock markets' relative positions in the global market network, although its impact varies with the economic development of their domicile countries. Furthermore, the DIO strategy offers a feasible and effective method for international portfolio diversification by jointly considering relative dominance and importance, verifying that portfolio diversification in terms of relative market position is beneficial.