International Portfolio Diversification: Currency, Industry and Country Effects Revisited



This paper analyzes the role of currency risk, industrial structure and country factors on international diversification strategies in the G7 countries over the past 30 years. We proposes a new test of the difference in Sharpe ratios of two portfolios that allows us to compare the relative efficiency of different portfolio strategies. We find that with monthly rebalancing, industry-based managed portfolios significantly outperform country-based managed portfolios. However, this out performance critically depends on the ability to go short: with long-only constraints both strategies show a similar performance. Strikingly, currency deposits are crucial for achieving the full benefits from international portfolio strategies: under no short sale restrictions, adding managed currency deposits to either country or industry based strategies nearly doubles their Sharpe ratio. Furthermore, a style analysis reveals that including currency as style portfolios significantly improves our ability to replicate the returns of international portfolio strategies.
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Ingolf Dittmann