European Business Schools Librarian's Group

ESSEC Working Papers,
ESSEC Research Center, ESSEC Business School

No DR 06013: International Portfolio Diversification Is Better Than You Think

Nicolas Coeurdacier () and Stéphane Guibaud ()
Additional contact information
Nicolas Coeurdacier: ESSEC Business School, Postal: Avenue Bernard Hirsch - B.P. 50105, 95021 CERGY-PONTOISE Cedex , FRANCE,
Stéphane Guibaud: London School of Economics and Political Science, Department of Finance, Postal: Room A352, Houghton Street, London WC2A 2AE, United Kingdom

Abstract: Do investors completely ignore the basics of portfolio theory? Given their over-exposure on domestic risk, investors should try to hedge this risk by picking foreign assets that have low correlation with their home assets. In the data though, we find a robust positive relationship between bilateral equity holdings and bilateral return correlations. We argue that this finding could be driven by the common impact of financial integration on cross-border equity holdings and on cross-market correlations. Indeed, when we instrument current correlations with past correlations to control for endogeneity, we recover asset demand functions that decrease with returns correlation.

Keywords: Endogeneity Bias; Financial Integration; International Portfolio Choice; International Stock Return Correlations

JEL-codes: G11; G15

30 pages, October 2006

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