Abstract
Financial liberalization may have double-edged impacts on international portfolio diversification since it increases financial market integration and market correlation simultaneously. Financial market integration enhances the possibility of diversifying portfolios internationally, while financial market correlation reduces the feasibility of such a diversification benefit. Using a dataset of stock market across 35 countries over the period 2001–2021, this paper examines the “possibility versus feasibility” puzzle arising from international portfolio diversification under financial liberalization. The empirical results show that financial liberalization has a positive (negative or no) impact on diversification benefits in its early (medium or developed) stage respectively due to its dual effects. Moreover, market integration positively affects diversification benefits only in the early stage of financial liberalization, while market correlation consistently has a negative impact on diversification benefits. Furthermore, this paper proposes an integration-correlation-oriented (ICO) diversification strategy to address the “possibility versus feasibility” puzzle, enabling international investors to make appropriate decisions on international portfolio diversification under financial liberalization.
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