InternationalPortfolioInvestmentChapter Twelve
Chapter Outline International Correlation Structure and RiskDiversificationOptimal International Portfolio SelectionEffects of Changes in the Exchange RateInternational Bond Investment International Mutual Funds: A Performance Evaluation International Diversification through Country FundsInternational Diversification with ADRsInternational Diversification with ETFsInternational Diversification with Hedge Funds Why Home Bias in Portfolio Holdings?International Diversification with Small-Cap Stocks
Chapter Outline ❖International Correlation Structure and Risk Diversification ❖Optimal International Portfolio Selection ❖Effects of Changes in the Exchange Rate ❖International Bond Investment ❖International Mutual Funds: A Performance Evaluation ❖International Diversification through Country Funds ❖International Diversification with ADRs ❖International Diversification with ETFs ❖International Diversification with Hedge Funds ❖Why Home Bias in Portfolio Holdings? ❖International Diversification with Small-Cap Stocks
International Correlation Structureand Risk DiversificationSecurity returns are much less correlatedacross countries than within a countryThis is true because economic, political,institutional, and even psychological factorsaffecting security returns tend to vary acrosscountries, resulting in low correlations amonginternational securities.Business cycles are often high asynchronousacross countries
International Correlation Structure and Risk Diversification ❖Security returns are much less correlated across countries than within a country. ▪ This is true because economic, political, institutional, and even psychological factors affecting security returns tend to vary across countries, resulting in low correlations among international securities. ▪ Business cycles are often high asynchronous across countries
International Correlation StructureAUFRJPNLUSGMSWUKStock Market.59Australia.29.58France.18.31.65Germany.15.24.30.42Japan.51.24.34.28.62Netherlands.52.36.37.28Switzerland.48.66United.32.38.30.21.39.70.43KingdomUnited States.30.23.17.14.27.27.28.44Relatively low international correlations imply that investors should be able to reduceportfoliorisk moreif they diversify internationallyratherthandomestically
International Correlation Structure Relatively low international correlations imply that investors should be able to reduce portfolio risk more if they diversify internationally rather than domestically. Stock Market AU FR GM JP NL SW UK US Australia .59 France .29 .58 Germany .18 .31 .65 Japan .15 .24 .30 .42 Netherlands .24 .34 .51 .28 .62 Switzerland .36 .37 .48 .28 .52 .66 United Kingdom .32 .38 .30 .21 .39 .43 .70 United States .30 .23 .17 .14 .27 .27 .28 .44 Relatively low international correlations imply that investors should be able to reduce portfolio risk more if they diversify internationally rather than domestically
Domestic vs.InternationalDiversificationWhen fully diversified, an international portfolio can beless than half as risky as a purely U.S. portfolio(%)A fully diversified international portfolio is only 12percent as risky as holding a single security0.44Swiss stocks0.27U.S. stocks0.12International stocksNumber20110304050ofStocks
Domestic vs. International Diversification 0.44 0.27 0.12 Portfolio Risk (%) Number 1 10 20 30 40 50 of Stocks Swiss stocks U.S. stocks International stocks When fully diversified, an international portfolio can be less than half as risky as a purely U.S. portfolio. A fully diversified international portfolio is only 12 percent as risky as holding a single security