Who Benefits More from International Diversification?

Abstract

This paper empirically investigates the relative magnitude of the benefits from international diversification for investors in countries at various developmental stages and in different geographical areas during the period of 1988-2004. Corresponding the motivations for overseas investment, the increase in risk-adjusted premium by investing the maximum Sharpe Ratio (MSR) portfolio and the reduction in volatility by investing the minimum-variance portfolio (MVP) for investors in each country are used to assess the diversification benefits. To ensure the feasibility of strategies of asset allocation, the constraints of short-sales and over-weighting investments are taken into account. The empirical results suggest that investors in less developed countries comparatively benefit more than those in developed countries from both regional and global diversification. Specifically, the investors in East Asia gain significantly more from increase in risk-adjusted return and decrease in volatility while the major benefit for Latin American countries is a reduction of risk. This result holds for efficient frontiers under various restrictions on allocation weights. Although the values of the MSR reduced and the standard deviation of MVP increased when the world financial market became more integrated, the investors in emerging markets, especially East Asia, and Latin America, still obtain comparatively higher benefits from global diversification than investors in the rest of the world. The cross-continent analyses suggest that the inclusion of securities from European or Latin American countries help investors in other regions generate the highest upsurge in risk-adjusted premiums. Adding North American or European assets effectively reduces the volatility of portfolios for investors in other areas. The results are useful for asset managers to determine target markets to promote their business.