Cross-country Diversification Research Articles

An Empirical Study of the Impact of the Euro on Cross-Country Diversification

The euro was launched, on 1 January 1999, as a common currency for members of the European Union that complied with the Maastricht Treaty. The Maastricht Treaty calls for the coordination of major macroeconomic policies, such as inflation, budget balance, public debt, and long-term interest rates. Theoretically, the coordination of these policy issues and the launch of a common currency will increase the degree of market integration among member countries. This paper empirically tests the impact of the euro on the degree of market integration by looking at the comovement of the European equity markets and a sample of OECD equity markets. Weekly stock market indices for the period covering seven years before the euro and seven years after the euro was implemented was used. The results show that cross-country divergences in stock markets continued after the euro. There is no evidence of cointegration after the adoption of the euro. Cross-country portfolio diversification continues to be beneficial even among euro countries.

Foreign bias in institutional portfolio allocation: The role of social trust

We study the role of social trust in the equity allocation decisions of global investors using a large sample of institutionally managed portfolios of 8,088 investors from 33 countries over the 2000 through 2017 period. The negative relationship between social trust and foreign bias suggests that institutional investors from high-social trust countries are less prone to underinvesting in foreign equity. Our results provide credence to an information-based explanation, indicating that social trust reduces foreign bias by compensating for the lack of information about foreign stock markets. Moreover, the effect of social trust on foreign bias is stronger if host-country institutions are weak, while it vanishes when the host country is characterized by strong institutions. The informal institution of social trust compensates for the lack of well-functioning formal country-level institutions in international portfolio decisions. Finally, the allocation effect resulting from social trust is different from “blind” trust. The portfolios of high-trust investors exhibit higher cross-country diversification and an enhanced portfolio risk-return trade-off.

Market segmentation and international diversification across country and industry portfolios

We conjecture that partially segmented stock indexes that are characterized by low correlation with the world market are mainly priced by local factors and should produce abnormal returns relative to a global asset-pricing model. This implies a negative relation between correlation and future index returns in the presence of segmented indexes. Empirical evidence confirms such a relationship for the sample of industry indexes, suggesting a heterogeneous segmentation. However, we do not observe a similar pattern for country indexes. In addition, the international diversification potential of industries does not vanish during volatile periods. The hypothesis that the negative relationship should be stronger for the more segmented subsamples that are characterized by small market size and emerging country origin is verified for the industry sample. Thus, cross-industry diversification is superior to mere cross-country diversification.

Specialisation, diversification and the ladder of green technology development

This paper elaborates an empirical analysis of the temporal and geographical distribution of green technology, and on how specific country characteristics enable or thwart environmental inventive activities. Using patent data on 63 countries over the period 1971–2012 we identify key drivers of cross-country diversification and specialisation. Our first finding is that countries diversify towards green technologies that are related to their existing competences. Notably, the degree of green technology maturity matters more than a country`s level of development. The second main result is that countries move along cumulative paths of specialisation, and towards more mature green technologies. Interestingly, the complexity of green technologies is not an obstacle to further specialisation. This holds also for developing countries that are most exposed to climate change hazards.

Diversification Through Trade*

AbstractA widely held view is that openness to international trade leads to higher income volatility, as trade increases specialization and hence exposure to sector-specific shocks. Contrary to this common wisdom, we argue that when country-wide shocks are important, openness to international trade can lower income volatility by reducing exposure to domestic shocks and allowing countries to diversify the sources of demand and supply across countries. Using a quantitative model of trade, we assess the importance of the two mechanisms (sectoral specialization and cross-country diversification) and show that in recent decades international trade has reduced economic volatility for most countries.

Specialisation, Diversification and the Ladder of Green Technology Development

This paper elaborates an empirical analysis of the temporal and geographical distribution of green technology, and on how specific country characteristics enable or thwart environmental inventive activities. Using patent data on 63 countries over the period 1970-2012 we identify key drivers of cross-country diversification and specialization. Our first finding is that countries diversify towards green technologies that are related to their existing competences. Notably, the maturity of the green technology matters more than the level of development of each country. The second main result is that countries move along cumulative paths of specialization, and towards more complex green technologies. Interestingly, the complexity of green technologies is not an obstacle to further specialisation. The latter holds also for developing countries that are most exposed to climate change hazards.

Evaluating investments in renewable energy under policy risks

The considerable amount of required infrastructure and renewable energy investments expected in the forthcoming years also implies an increasingly relevant contribution of private and institutional investors. In this context, especially regulatory and policy risks have been shown to play a major role for investors when evaluating investments in renewable energy and should thus also be taken into account in risk assessment and when deriving risk-return profiles. In this paper, we provide a stochastic model framework to quantify policy risks associated with renewable energy investments (e.g. a retrospective reduction of a feed-in tariff), thereby also taking into account energy price risk, resource risk, and inflation risk. The model is illustrated by means of simulations and scenario analyses, and it makes use of expert estimates and fuzzy set theory for quantifying policy risks. Our numerical results for a portfolio of onshore wind farms in Germany and France show that policy risk can strongly impact risk-return profiles, and that cross-country diversification effects can considerably decrease the overall risk for investors.

Should banks be geographically diversified? Empirical evidence from cross-country diversification of European banks

Using a sample of European bank, this paper investigates the impact of banks' geographic diversification on their cost of equity capital. Examining the geographic diversification of European banks gives an insight on the value of cross-border banking. To measure diversification between major geographic areas in which the bank operates, the Herfindahl–Hirschman Index, based on revenues generated at home and abroad is constructed for each bank. To address the problem of endogeneity, system generalized method of moments estimator is used. The main finding of the analysis is that, other things equal, more geographic diversified banks have higher cost of equity capital than geographically focused ones. This result implies that the adverse market valuation effect of geographic diversification (increase in agency problem) dominates the positive ones (increase in efficiency and reduction in risk).

Latin American Company Strategies in the Financial Crisis

This article presents a conceptual basis for developing a corporate strategy to respond to a financial crisis, and an empirical examination of strategic moves undertaken by a number of large Latin American (Mexican) firms during the crisis and subsequent recession. A framework for thinking about this problem is the Cost–Revenue–Risk (CRR) view,1 which focuses on the firm’s costs, revenues, and risks. This framework is elaborated in the article, and then applied empirically to six companies in Mexico, looking at their responses to the crisis initially and after one year. In addition, the firms listed on the Mexican stock exchange are examined to see if the strategies used by the interview sample also contribute to performance of the larger group of firms—which they do. In the sample of listed Mexican firms, both sectoral diversification and cross-country diversification turned out to be significant contributors to explaining relative firm performance during the crisis.

Is Currency Factor Important for Global Portfolios?

We investigate whether cross-country diversification, particularly into emerging markets, has an impact on the pricing of exchange risk for globally diversified portfolios. Our empirical tests based on a conditional IAPM show that the price of exchange risk is highly significant in global sector portfolios that include only developed countries. In contrast, when we include emerging markets with the developed market assets, the hypothesis of zero price of exchange risk cannot be rejected. Also, global sector portfolios that include EM assets show lower currency beta and lower contribution of the currency premium on average. The reduction in the contribution of the currency premium is specifically important in periods of crises.

An Empirical Examination of the Inter-Linkages between African Stock Markets

This paper examines the nature and extent of inter-linkages between African stock markets and the relationships between these markets and that of the regional and global indices. We present evidence to show that African stock markets are still segmented from global markets. We also find evidence of time varying integration to the global market but the level integration rather diminishes over time. In addition, we find that a large part of the total volatility of the domestic index appears largely country-specific which can be diversified away by cross-country diversification.

Modelling Price Dynamics in the Hong Kong Property Market

The property market in Hong Kong plays an important role in the political, social and economic life of this vibrant city. Understanding the dynamics of the market is essential to guide government policy making and investment decisions. Using data collected between 1993 and 2006, this study investigates the monthly returns, volatilities and time-varying correlations in the residential, office, and retail property markets in Hong Kong. A vector autoregressive (VAR) model is used to examine the conditional mean, and a multivariate generalized autoregressive conditional heteroscedasticity (MGARCH) model is adopted to analyze the conditional variance. The dynamic conditional correlation (DCC) approach is utilized to specify the MGARCH model. All of the property types show strong auto- and cross-correlations, which indicates that the sectors relate to each other closely. All three sectors have higher volatilities when major political and economic events occur. The findings reveal the possibility of balancing investment portfolios between the three sectors in the Hong Kong property market. However, it is difficult to achieve a well-diversified portfolio only by cross-property investment for the Hong Kong REITs. REIT managers should also consider cross-country diversification to reduce the investment risk. Furthermore, exposure to the residential sector may reduce the chance of investment diversification because of the higher correlation of this sector with the other property sectors.