Country-Specific Risk Diversification through Internationa Equity Portfolios

The existence of country-specific risk factors that could be mitigated by international investment is investigated. An innovative methodology for quantifying the benefits of international diversification is also proposed and tested. In order to overcome many of the problems that arise in the study of international diversification, the analysis is restricted to the equity markets of the Eurozone. The results clearly show the benefits of international equity diversification, even in close economies. The introduction of constraints on short selling significantly reduces these benefits. For asset managers and practitioners, the analysis shows unambiguously that, despite the economic and monetary union and notwithstanding the high degree of correlation between the European markets, opportunities for diversification into the national stock markets of the Eurozone still exist. There is, furthermore, a significant country-specific source of risk that can be hedged via the use of non-domestic diversification.