Benefits of International Diversification

“An argument often heard is that correlations between international equity returns are higher during bear markets than during bull markets, and bear market moves are greater than bull market moves.1 This would suggest that the benefits of international diversification are less impressive than conventional wisdom predicts. This argument is potentially very important since it may help explain the “home bias puzzle,” arguably one of the most important puzzles in international finance. If the diversification benefits from international investing are not forthcoming at the time that investors need them the most (when their home market experiences a downturn), international investing may not be worth the trouble” (Ang & Bekaert, 2000, p. 3). Ang and Bekaert (2000) conclude that the volatility of the bear market does not “negate the benefits of international diversification” (p. 28). They offer three main results as evidence: “there are always large benefits to international diversification”; “the costs of ignoring regime switching may be small or large depending on the presence of a conditionally risk-free asset”; and, “intertemporal hedging demands under regime switches are economically negligible and statistically insignificant” (Ang & Bekaert, 2000, pp. 27-28).
Reference:
Ang. A. and Bekaert, G. (2000). International asset allocation with regime shifts. White Paper. Retrieved January 27, 2009 from https://content.putnam.com/panagora/pdf/crowell_winner01.pdf.