Local Factors and the Gains from International Diversification
The rising correlation and convergent risk-return characteristics of international stock markets observed in recent years have increasingly called into question the benefits from international diversification. Against this backdrop, we propose a new diversification strategy involving local factor funds in this paper. As shown by Fama and French (1998), Griffin (2002) and others, the size, book-to-market, and momentum factors help better explain international stock returns and are substantially local rather than global. From the portfolio perspective, this implies that investors may be able to enhance the mean-variance efficiency of their portfolios using these local factor funds. In this paper, we formally investigate this possibility by focusing on the potential of local factor funds as a vehicle for international diversification. In doing so, we consider three factor funds from each of the ten major countries in our sample. The key findings of the paper include: First, unlike country market indices which are all substantially positively correlated with the U.S. market index, the majority of local size, book-to-market, and omentum factors are negatively correlated with the U.S. market index. In addition, both intra- and inter-factor correlations are low internationally. Second, the augmented optimal international portfolio, which comprises the factor funds as well as country market indices, has a Sharpe performance ratio (0.76) during our sample period 1991- 2004, far exceeding that (0.19) of the benchmark optimal international portfolio comprising country market indices. Among the three factor classes considered, the bookto- market funds contribute the most to the portfolio efficiency. Third, the gains from international factor diversification remain robust to both in-sample and out-of-sample periods and to a realistic range of additional investment costs for factor funds. Lastly, we document that the benefits from international diversification using market indices have declined over time, while those using local factor funds have not.
International diversification Local factors Factor funds
Cheol S.Eun Sandy Lai Zhe Zhang
College of Management Georgia Institute of Technology Atlanta,GA 30332-0520,USA Lee Kong Chian School of Business Singapore Management University Singapore 178899
国际会议
成都
英文
2007-07-09（万方平台首次上网日期，不代表论文的发表时间）