Oops, we should have diversified!

Abstract

This article extends the research on the improvements to the efficient portfolio frontier in globally diversified portfolios. We examine efficient frontiers of regional equity portfolios from developed and undeveloped countries. We show that a globally diversified portfolio has higher reward with less risk than individual regional portfolios. We also show that, in the past 8 years, a US investor would have achieved higher returns for the same risk if diversified in emerging and frontier markets. These results have implications for practical portfolio selection as well as empirical applications of Capital Asset Pricing Model (CAPM).

Notes

¹ We interpret a negative weight as that proportion of the portfolio which is borrowed from or, in other words, sold short in that particular market.

² We have not converted the local currency price indices to USD denominated prices primarily because daily data for the USD exchange rate is not available for many of the developing markets of the sample. In addition, we believe that using local currency prices may in fact be a good choice because our results may have implications for the issue of currency diversification as well.

³ Data for the individual countries are available upon request. Based on data availability, the short term interest rate is measured by one of the following series: Treasury bill rate, money market rate, deposit rate, or prime lending rate.

⁴ In Fig. 2, we group two regions at a time for better comparison of the frontiers and to conserve space.