Diversification Versus Segmentation and Integration in Financial Markets

Abstract

This article examines the integration/segmentation between developed and emerging markets and its implications on the gains generated by international diversification. Both theoretical and empirical studies agree on the benefits of international diversification in terms of reducing total risk and increasing portfolio returns, showing that the gains from international diversification are superior to domestic diversification. However, the effectiveness of this strategy remains contingent on the level of market integration. Indeed, when markets are financially and economically integrated, potential gains will be low or even nonexistent. Conversely, when markets are segmented, gains will be significant. The sample for our empirical analysis consists of thirty-five financial markets: nineteen markets in Europe and Central Asia, nine markets in East Asia and the Pacific, four markets in Latin America and the Caribbean, and two markets in North America. These countries are classified according to the World Bank. The study covers the period from 01/2006 to 12/2022. Our results show that the gains from international diversification, are statistically and economically significant for all countries in the sample.