Can home-biased investors diversify interregionally in the long run?

Abstract

We examine the case of long-term home-biased equity investors seeking international diversification opportunities in their region of Asia, Central and Eastern Europe (CEE), Latin America, or the Middle East and North Africa (MENA). Our study employs panel cointegration tests and vector autoregressive error-correction (VECM) models to examine region-wise long-run relationships over the period January 3, 2000 to December 30, 2016. Our analysis allows for US investor sentiment, the global financial crisis, movements in the S&P 500, and oil prices. Our main findings suggest that for home-biased Asian investors, investment within Asia is somewhat attractive because a stable long-run relationship between Asian markets has been absent, even after controlling for certain economic and financial conditions. For other investors, there are limited long-term diversification benefits within their regions. An examination of long-run correlations between the markets implies that regional diversification opportunities for MENA investors exceed those for CEE and Latin American investors.