Abstract
We employ mean‐variance spanning and intersection tests in the stochastic discount factor approach to examine the potential diversification benefits of international investments from the perspective of Korean investors. Our results show that the addition of international regional indices to the set of domestic equities provides significant diversification benefits. However, the source and economic magnitude of diversification benefits differ across international markets. Furthermore, we find that when investors manage their portfolio based on instrument variables, they can not only expand their investment opportunities by investing in international assets, but also increase the efficiency gain of diversification benefits.
Highlights
Over the past decades there has been the growth of international investment opportunities faced by domestic investors due to financial deregulation around the world and a large number of lifting of investment restrictions faced by institutional investors
International investment opportunities are attractive for domestic investors because they provide potential opportunities to reduce the risk of their portfolio given the small correlations across international equity markets [Dimson, Marsh, Staunton (2002)]
2.1 Spanning and intersection test We employ the mean-variance spanning and intersection tests to determine whether investment opportunities consisted of benchmark assets plus test assets are statistically different from those consisted of benchmark assets only
Summary
Over the past decades there has been the growth of international investment opportunities faced by domestic investors due to financial deregulation around the world and a large number of lifting of investment restrictions faced by institutional investors. Despite the international diversification benefits, evidence on home bias suggests that investors have been reluctant to invest more than small fraction of their wealth in foreign financial assets [French and Poterba (1991) and Tesar and Werner (1995)]. A number of related studies investigate international portfolio diversification benefits from a U.S perspective. Harvey (1995) shows that US investors can gain large benefits from investing in emerging markets. Hogan, and Hung (1999) show that international diversification benefits can be achieved indirectly at home through investing in multinational companies, American depository receipts and country funds, which trade in the USA. DeRoon, Nijman, and Werker (2001) show that the benefits of international diversification disappear for US investors once market frictions such as short-sales constraint and transaction costs are incorporated
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