Geographic Versus Industry Diversification: Contraints Matter
This research addresses whether geographic diversification provides benefits over industry diversification in a sample of European country and industry indexes. The methodology allows performance comparisons with short-selling constraints, upper and lower bounds, and many benchmarks. In the absence of constraints, no empirical evidence is found to support the argument that country diversification is a superior approach. In the case of realistic weights on portfolios such as short-selling, and lower or upper bonds, geographic diversification performs (sig-nificantly) better. The contrary results appear to be attributable to the fact that industry portfolios are better suited to eliminate the single dominant factor risk in stock returns. Further out-of-sample analysis shows that geographic diversification performs better, although the tests do not show statistical significance.
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