International portfolio diversification: Currency, industry and country effects revisited

• Published in: Journal of international money and finance Vol. 31; no. 5; pp. 1249 - 1278
• Main Authors: Eiling, Esther, Gerard, Bruno, Hillion, Pierre, de Roon, Frans A.
• Format: Journal Article
• Language: English
• Published: Kidlington Elsevier Ltd 01.09.2012; Elsevier Science Ltd
• Subjects: Conditioning information; Correlation; Currencies; Currency; Currency risk; Diversification; Equity; Expected returns; International finance; International financial markets; International market; Investment policy; Investment strategies; Mean-variance efficiency; Portfolio diversification; Risk factors; Stock returns; Studies; International financial markets; G15; Mean-variance efficiency; Currency risk; G11; Conditioning information
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2012.01.015

We examine the relative importance of country, industry, world market and currency risk factors for international stock returns. Our approach focuses on testing the mean-variance efficiency of the various factor portfolios. An unconditional analysis does not show significant differences between country, industry and world portfolios, nor any role for currency risk factors. However, when we allow expected returns, volatilities and correlations to vary over time, we find that equity returns are mainly driven by global industry and currency risk factors. We propose a novel test to evaluate the relative benefits of alternative investment strategies and find that including currencies is critical to take full advantage of the diversification benefits afforded by international markets.