Corporate International Diversification and Market Assigned Measures of Risk and Diversification

TLDR

Capital markets are largely integrated in returns and systematic risk, yet investors can still lower total risk through international diversification, though imperfect integration due to capital‑flow controls, trading costs, and tax differences limits full benefits. The studies suggest that markets are not perfectly integrated, so investors may fail to diversify internationally and miss potential benefits.

Abstract

Recent evidence supports the notion that capital markets are substantially integrated in a return/systematic risk sense [1, 12]. Other studies show that investors can reduce the total level of risk borne without reducing expected returns by holding an internationally diversified portfolio [8, 9, 17]. Together these studies imply that the various economies mirrored by financial markets are not perfectly integrated. Some assert, however, that because of controls on capital flows, differential trading costs, different tax structures, and a number of other factors, markets are imperfectly (albeit substantially) integrated. Hence investors may not actually be diversifying internationally and thus forego advantages which would accrue to them if they were willing to hold foreign security issues.