What Extent the Principles of International Portfolio Diversification Are Still Applicable?

Given the globalisation of financial markets, discuss to what extent the principles of international portfolio diversification are still applicable.

, December 2006

What is the globalisation of financial market? The term has been with us since 1800 (World Bank 2000) when many were optimistic about an inevitable free capital floatation and liberalized global capital market. Das (2004) derives that there are approximately one hundred definitions of globalization, which includes economic and financial issues, as well as social, environmental and military concepts. According to World Bank, globalisation is integration through trade and factor mobility, and the Organisation for Economic Cooperation & Development defines globalisation as the structure of markets, technology and communication patterns becoming more international over time movement (Jonathon Jones et al 2006).

“Corus accepts £4.3bn Tata Offer” (bbc online 20th October 2006).

The above quoted heading is a perfect example of globalisation of financial market for portfolio diversification. An emerging market company taking over worlds 9th largest steel company in developed market do not surprises us anymore. The phenomenon of higher foreign turnover rate in compare with domestic turnover rate encourages investor to invest in foreign equities (Amir A. Amdi et al 2006). On the other hand according to A. Antoniou et al (2006) International portfolio diversification has not yet been widely accepted in compare to Home-Made Diversification. The objective of this essay is to justify to what extent the international portfolio diversification is applicable on global market.

Is it a sensible decision to diversify internationally? This is a common question to every investors mind. To satisfy this question we have to compute the returns on foreign assets and do the standard deviation and correlation analysis. Cross border investment also depends on the changes in exchange rates of different countries.

The empirical study defines the foreign turnover rate as the total transaction that occurs within a given year divided by the foreign asset position at the end of the year. The domestic turnover rate is defined as the total domestic market transactions in a year divided by the year-end domestic market capitalisation.

The return on a foreign investment is affected by the return on the assets within its own market and the change in the exchange rate between the security’s own currency and the currency of the purchaser’s home country. That’s why the return on a foreign investment is different than simply the return in the asset’s own