Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
Counter to extant stylized facts, using newly available data on country allocations in U.S. investors' foreign equity portfolios we find that (i) U.S. investors do not exhibit returns-chasing behavior, but, consistent with partial portfolio rebalancing, tend to sell past winners; and (ii) U.S. investors increase portfolio weights on a country's equity market just prior to its strong performance, behavior inconsistent with an informational disadvantage. Over the past two decades, U.S. investors' foreign equity portfolios outperformed a value-weighted foreign benchmark by 160 basis points per year.
Recent changes in technology, along with the opening up of many regions previously closed to investment, have led to explosive growth in the international movement of capital. Flows from foreign direct investment and debt and equity financing can bring countries substantial gains by augmenting local savings and by improving technology and incentives. Investing companies acquire market access, lower cost inputs, and opportunities for profitable introductions of production methods in the countries where they invest. But, as was underscored recently by the economic and financial crises in several Asian countries, capital flows can also bring risks. Although there is no simple explanation of the currency crisis in Asia, it is clear that fixed exchange rates and chronic deficits increased the likelihood of a breakdown. Similarly, during the 1970s, the United States and other industrial countries loaned OPEC surpluses to borrowers in Latin America. But when the U.S. Federal Reserve raised interest rates to control soaring inflation, the result was a widespread debt moratorium in Latin America as many countries throughout the region struggled to pay the high interest on their foreign loans. International Capital Flows contains recent work by eminent scholars and practitioners on the experience of capital flows to Latin America, Asia, and eastern Europe. These papers discuss the role of banks, equity markets, and foreign direct investment in international capital flows, and the risks that investors and others face with these transactions. By focusing on capital flows' productivity and determinants, and the policy issues they raise, this collection is a valuable resource for economists, policymakers, and financial market participants.
This timely volume addresses three important recent trends in the internationalization of United States equity markets: extensive market integration through foreign investment and links among stock prices around the world; increasing securitization as countries such as Japan come to rely more than ever before on markets in equities and bonds at the expense of banks; and the opening of national financial systems of newly industrializing countries to international financial flows and institutions, as governments remove capital controls and other barriers. Eight essays examine such issues as the current extent of international market integration, gains to U.S. investors through international diversification, home-country bias in investing, the role of time and location around the world in stock trading, and the behavior of country funds. Other, long-standing questions about equity markets are also addressed, including market efficiency and the accuracy of models of expected returns, with a particular focus on variances, covariances, and the price of risk according to the Capital Asset Pricing Model.
The benefits of international diversification have been recognized for decades. In spite of this, most investors hold nearly all of their wealth in domestic assets. In this paper, we construct new estimates of the international equity portfolio holdings of investors in the U.S., Japan, and Britain. More than 98% of the equity portfolio of Japanese investors is held domestically; the analogous percentages are 94% for the U.S., and 82% for Britain. We use a simple model of investor preferences and behavior to show that current portfolio patterns imply that investors in each nation expect returns in their domestic equity market to be several hundred basis points higher than returns in other markets. This lack of diversification appears to be the result of investor choices, rather than institutional constraints.
The International Equity Commitment refutes that rising correlation and costs, increasing exchange rate volatility, and underperformance of non-U.S. markets make investing in international equity undesirable, or, at best, irrelevant. The author uses a detailed analysis of the data to show not only that historical evidence supports a strategic allocation to international equity, but that the typical U.S. pension plan is underexposed.
This paper studies the cross-border transactions in equity by investors in Canada, Germany, Japan, the U.K. and the U.S. We find that investors from different countries make very different decisions about the allocation of their portfolio across markets. In contradiction to the notion that high variable transactions costs hinder international diversification, we find that the volume of gross equity flows vastly exceeds net equity flows and the turnover rate on foreign equity investments by some investors even exceeds domestic turnover rates. We also reject the hypothesis that U.S. investors follow the standard CAPM in allocating their global equity portfolio.
Over the past two decades international markets have become more open, leading to a common perception that global capital markets have become more integrated. In this paper, I ask what this integration and its resulting higher correlation would imply about the diversification potential across countries. For this purpose, I examine two basic groups of international returns: (1) foreign market indices and (2) foreign stocks that are listed and traded in the US. I examine the first group since this is the standard approach in the international diversification literature, while I study the second group since some have argued that US-listed foreign stocks are the more natural diversification vehicle (Errunza et al (1999)). In order to consider the possibility of shifts in the covariance of returns over time, I extend the break-date estimation approach of Bai and Perron (1998) to test for and estimate possible break dates across returns along with their confidence intervals. I find that the covariances among country stock markets have indeed shifted over time for a majority of the countries. But in contrast to the common perception that markets have become significantly more integrated over time, the covariance between foreign markets and the US market have increased only slightly from the beginning to the end of the last twenty years. At the same time, the foreign stocks in the US markets have become significantly more correlated with the US market. To consider the economic significance of these parameter changes, I use the estimates to examine the implications for a simple portfolio decision model in which a US investor could choose between US and foreign portfolios. When restricted to holding foreign assets in the form of market indices, I find that the optimal allocation in foreign market indices actually increases over time. However, the optimal allocation into foreign stocks decreases when the investor is allowed to hold foreign stocks that are traded in the US. Also, the minimum variance attainable by the foreign portfolios has increased over time. These results suggest that the benefits to diversification have declined both for stocks inside and outside the US.
