Abstract
Many studies show that country effects dominate in determining the stock return cross-sectional variations. After removing three potential distortions (domestic inflation rate, exchange rate and local risk-free interest rate), we find that the common practice of decomposing the nominal return converted into a single currency misestimates the importance of country effects, and hence may lead to incorrect inferences regarding portfolio diversification.
Acknowledgement
I would like to thank the useful suggestions and comments from two anonymous referees and the editor of Applied Financial Economics.
Notes
4 We omit time subscripts to economize on notation.
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