The effectiveness of international diversification: whole markets versus sectors

Abstract

A hedging approach is used to examine the effect of sectoral factors on the effectiveness of international diversification. By using data covering seven countries and various sectors, we find that international diversification is more effective when assets from developed markets only are used and when multiasset portfolios are used instead two-asset portfolios. The results also reveal that international diversification across whole markets is more effective than diversification across sectors. These results reflect the pattern of return correlation.

Keywords:

• international diversification
• variance ratio
• variance reduction

JEL Classification:

• F21
• G11
• G15

Acknowledgements

We would like to thank an anonymous referee for comments on an earlier draft. We are grateful to Kelly Burns for providing the data and Brett Shanahan for excellent research assistance. Work on this project was financed by a generous grant from the Australian Centre for Financial Studies, which we acknowledge gratefully.