International diversiﬁcation has costs and beneﬁts, depending on the degree of asset dependence. In light of theoretical research linking diversiﬁcation and dependence, we examine international diversiﬁcation with two dependence measures: correlations and extreme dependence. We document several ﬁndings. First, dependence has generally increased over time. Second, there is evidence of asymmetric dependence or downside risk in all regions, albeit at different times. Surprisingly, recent Latin American returns exhibit little downside risk. Third, Latin America exhibits a great deal of correlation complexity. Fourth, extreme dependence is related to returns. Our results suggest international limits to diversiﬁcation. They are also consistent with a possible tradeoff between international diversiﬁcation and systemic risk.
Introduction: Understanding the net beneﬁts of international diversiﬁcation is important in today’s eco-nomic climate. In general, the balance between diversiﬁcation’s beneﬁts and costs hinges on the degree of dependence across securities, as observed by Samuelson (1967), Veldkamp and Van Nieuwerburgh (2008), Ibragimov, Jaffee, and Walden (2009b), and Shin (2009), among others. Diversiﬁcation beneﬁts are typically assessed using a measure of depen-dence, such as correlation. It is therefore vital for investors to have accurate measures of dependence. There are several measures available in ﬁnance, including the traditional correlation and extreme dependence. While each approach has advantages and disadvan- tages, they rarely have been compared in the same empirical study. Such reliance on one dependence measure prevents easy assessment of the degree of international diversiﬁcation opportunities, and how they differ over time or across regions.
Author: Loran Chollete,Victor de la, Pena, Ching-Chih Lu
Source: University of Stavanger
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