Implications for Risk Reduction Through International Diversification

The growing awareness fhat different national equity markets often perform very differenfly in any given period has led to increased investor interest in international diversification of investment portfolios. It appears that at least for fhe U.S., however, fhis interest has not been translated intt> much actual foreign portfolio investment. One reason tor this may be the relative novelty of toreign investment and the special problems it poses. Equity investing in international markets ditfers from equity investing in the domestic market in three important respects: (1) The covariances among securities within national niarkets are much higher than the covariances among securities in different markets. National factors have a strong impact on security returns relative to any common world factor. This contrasts with the more familiar covariance structure of the single market, like thaf of the U.S., uhere there is a well defined nafional market factor and few stable relationships among refurns iin individual securities beyond this factor. (2) Barriers imposed by taxation, currency con-