Chapter_11 - Chapter Outline International Correlation...

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Chapter Outline International Correlation Structure and Risk Diversification Optimal International Portfolio Selection Effects of Changes in the Exchange Rate International Bond Investment International Mutual Funds: A Performance Evaluation
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Chapter Outline (continued) International Diversification through Country Funds International Diversification with ADRs International Diversification with WEBS Why Home Bias in Portfolio Holdings?
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International Correlation Structure and Risk Diversification Security returns are much less correlated across countries than within a country. This is so because economic, political, institutional, and even psychological factors affecting security returns tend to vary across countries, resulting in low correlations among international securities. Business cycles are often high
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International Correlation Structure Stock Market AU FR GM JP NL SW UK US Australia (AU) .586 France (FR) .286 .576 Germany (GM) .183 .312 .653 Japan (JP) .152 .238 .300 .416 Netherlands (NP) .241 .344 .509 .282 .624 Switzerland (SW) .358 .368 .475 .281 .517 .664 United Kingdom (UK) .315 .378 .299 .209 .393 .431 .698 United States (US) .304 .225 .170 .137 .271 .272 .279 .439 Relatively low international correlations imply that investors should be able to reduce portfolio risk more if they diversify internationally rather than domestically.
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Domestic vs. International Diversification 0.44 0.27 0.12 PortfolioRisk(%) Number of Stocks 1 10 20 30 40 50 Swiss stocks U.S. stocks International stocks When fully diversified, an international portfolio can be less than half as risky as a purely U.S. portfolio. A fully diversified international portfolio is only 12 percent as risky as holding a single security.
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Optimal International Portfolio Selection The correlation of the U.S. stock market with the returns on the stock markets in other nations varies. The correlation of the U.S. stock market with the Canadian stock market is 70%. The correlation of the U.S. stock market with the Japanese stock market is 24%. A U.S. investor would get more diversification from investments in Japan than Canada.
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Summary Statistics for Monthly Returns 1980-2001 ($U.S.) Stock Market Correlation Coefficient Mean (%) SD (%) β CN FR GM JP UK Canada (CN) .88 5.78 0.99 France (FR) 0.46 1.19 6.29 1.00 Germany (GM)
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Chapter_11 - Chapter Outline International Correlation...

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