Working Paper: NBER ID: w18627
Authors: Karen K. Lewis; Sandy Lai
Abstract: How important is foreign diversification? In this paper, we re-examine this question motivated by findings from the literature about foreign companies that are listed on US exchanges. Specifically, domestic portfolios including cross-listed stocks can provide the same diversification as foreign market returns without the need for US investors to go abroad. At the same time, the betas of these foreign stock returns against the US market increase after cross-listing, suggesting diversification worsens over time. In this paper, we assess the impact of these changes on foreign diversification for a US investor. We test for and estimate breaks in the sensitivity of individual foreign stocks listed on US exchanges. We find that roughly half of the changes in betas arise from greater integration between the U.S. and the companies' home markets, not in the companies betas themselves. Moreover, the gains from diversifying into these stocks has declined over time.
Keywords: Foreign Diversification; Crosslisted Stocks; Market Integration; Beta Changes; US Investors
JEL Codes: C32; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Greater integration between the US market and the companies' home markets (F69) | Increase in betas of foreign stocks (G15) |
| Increase in betas of foreign stocks (G15) | Diminished potential for diversification for US investors (F29) |
| Gains from diversifying into crosslisted stocks (G15) | Decline over time (C41) |