International Equity Flows, Dominant Distributions and Diversification

Abstract

The weak empirical evidence linking diversification and international equity flows calls into question the diversification paradigm at the international level and the analytical framework it implies. Using a novel measure of diversification that includes all the moments of the distribution of equity returns rather than just the first two, this paper reexamines the role that diversification opportunities play in the determination of international equity flows. Using the concept of Marginal Conditional Stochastic Dominance (MCSD) to estimate the diversification opportunities, it provides strong evidence that diversification opportunities are significant determinants of international equity flows and that these opportunities are concentrated on the dominant distributions, thereby implying a tendency towards MCSD efficiency. It also shows that the relationship between diversification opportunities and equity flows is much stronger for developed markets than for emerging markets. These results are robust with respect to a range of conventional control variables documented in the outstanding literature.