Domestically formed international diversification

Qinye Lu and Andrew Vivian

Journal of International Money and Finance, 2020, vol. 103, issue C

Abstract: We examine whether portfolios of U.S. stocks can mimic foreign index returns thereby providing investors with the benefits of international diversification without investing directly in assets that trade abroad. We study 7 developed markets and 8 emerging markets over 1975–2013. Portfolios of U.S. stocks are constructed out-of-sample to mimic these international indices using a range of domestically available assets. We show that investors can gain considerable exposure to foreign indices using domestically traded stocks. Results indicate increases in exposure to the foreign market are strongest when emerging markets are mimicked. Our out-of-sample portfolio choice analysis shows that for most cases mimicking portfolios can be a good substitute for direct foreign investment. Hence, a possible explanation for the high proportion of domestic stocks held by investors and fund managers is that such assets are sufficient to provide much of the benefits of international diversification without directly investing abroad.

Keywords: International diversification; Home bias; Mean-variance spanning; Portfolio choice (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:103:y:2020:i:c:s0261560619306473

DOI: 10.1016/j.jimonfin.2019.102131

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