Human Capital and International Diversification

Abstract

International portfolio diversification is looked at from an unusual perspective: the interaction between human capital and international diversification. The author notes that, despite well-grounded arguments in favor of international diversification, Americans hold an almost insignificant proportion of foreign stocks in their portfolios. The author examines the effects of human capital to see whether adding that dimension helps explain that apparent puzzle. He shows that extremely risk-averse investors may choose to own domestic equity only when human capital is considered, although extremely risk-averse investors may not choose to diversify internationally, even if human capital is ignored. Furthermore, the data support the contention that more representative investors should diversify internationally, but that this result does not seem to depend much on human capital. The author argues that the experiment reconciles several different previous findings, but concludes that, in general, his results seem to indicate that the degree of international diversification in an individual9s portfolio depends largely on the investor9s attitude toward risk.