Strategic Returns to International Diversification

Opinions expressed herein do not necessarily concur with the Federal Reserve Board or any other employees of the Federal R.eserve System. The authors are also grateful co Stephen Brown for providing some of the international stock market data. Some of the UK stock market data used in the analysis herein were extracted from the London Share Price Database, which is a copyright work of the L,ondon Business School. Abstract We undertake a decomposition of the risk factor loadings of fifteen national stock market returns from 1972 to 1990, using a variant of the Campbell-Shiller (1988) linearization. We find considerable variation among countries in the relative importance of a cash flow component and a discount rate component in determining the beta with the world equity index return and with other risk factors. Also, the substantial international heterogeneity in factor loadings suggests that a global portfolio allows ample hedging opportunities, presumably deriving from differences in underlying economic structure.