International portfolio diversification and genetic relatedness

The purpose of this paper is to shed some light on how relatedness between counterparties can explain investment behavior, specifically how much can investor’s inherited traits influence the exchange of capital. We use the genetic distance index and regress it against the foreign bias measure on pairs from 40 countries on a time period from 2001-2016. We identify that the prior exerts a significant impact on foreign investment decision, even when controlling for previous documented determinants of foreign bias. These findings reflect that international portfolio allocation is obstructed by the cultural wedge created between source and destination country, since relative difference in these characteristics disturb the flow of equity investments across markets, which ultimately hinder diversification.

MULTI-FACTOR MODELS FOR INVESTMENT PREMIUMS VALUATION: DISCOURSE ANALYSIS AND ITS PLACE IN THE PARADIGM OF INTERNATIONAL PORTFOLIO INVESTING

The paper dwells on multi-factor models of individual securities and investment portfolios expected returns and investment premiums valuation. Main stages of these models appearance and development are discovered. Theory and practice realized that single-index models were not relevant in terms of estimating expected returns, since at least several basic factors affected premiums substantially. Notwithstanding the basic principle of compensating risk beared by respective return remained unchanged two new models – intertemporal CAPM and international CAPM were underlying dynamic development of multi-factor models. The latter along with market risk factor considered other premium components like those resulting from exchange rate risks for different currencies. Components of scientific discourse in this field are identified, position of models under question in contemporary theory of international portfolio investing is defined. Multi-factor models expanded and enhanced portfolio paradigm of international investing, particularly its specific concept of expected returns valuation. Unlike some other paradigm components this concept is proved to be positive theoretically and well applicable in practice. Factors of international models of investment premiums valuation origin are specified. More precise emphasize is made on international multi-factor CAPM and APT models. More cross functional nature of arbitrage pricing model compared to CAPM is justified. Gnoseological status of Fama and French multi-factor model is specified. Its affiliation with both existing paradigms of international investing – value investing and portfolio paradigm is argued. This in turn determines its unique position in existing knowledge in the field. Technically and methodologically it was developed on the ground of traditional CAPM model – it implies existing risk factor, specific sensitivity ratio to the existing risk factor and respective investment premium. This justifies the model affiliation with traditional and dominating portfolio paradigm of international investing. On the other hand, in its current version the model completely corresponds with value paradigm principles. Intrinsic, internal value of securities is defined, the valuation is subjective, traditional fundamental analysis ratios like book-to-market value index are used. The model thus establishes particular connection between two paradigms of international portfolio investing.

BEHAVIORAL BIASES IN INVESTMENT DECISIONS: HOME BIAS CASE

The place of home bias in the modern paradigm of international portfolio investing is determined. The differences between theory and practice of international portfolio investing resulting from such a bias are identified. Main advantages of international diversification of investment portfolios in terms of performance-risk ratio are defined. It is determined that the growing level of financial markets globalization accompanied by the increase in correlation of returns of financial assets have not affected the benefits of international diversification. The primary problems in determining the reasons for home bias are identified. The main economic and mathematical formalization of home bias in the form of indexes is distinguished. The local bias is investigated. It is revealed that local bias is not limited to national borders. It is determined that home bias is negatively correlated with the wealth of an investor. The extent of home bias for particular groups of countries according to their level of economic development is investigated. It is determined that the highest level of home bias is observed in several developed markets, including China, Japan, the USA, and France, while Luxembourg, the Netherlands, and Switzerland have the highest level of international diversification. The benefits of international diversification based on the MSCI indexes are determined. It is revealed that the benefits from international diversification through emerging markets are higher than those of developed markets. A comparative analysis of portfolios of several countries in the instruments of foreign and local markets is carried out. It is determined that the Great Recession of 2007-2008 promoted the increase in the level of home bias but since 2013 the global level of international diversification has been increasing. Approaches to the analysis of factors of presence of home bias are determined and their main advantages and disadvantages are analyzed based on comparative analysis. The impact of asymmetry of information, financial reporting standards, non-tradable sector of the economy, volumes of investment, inflation, transaction costs, institutional factors on the level of international diversification of the investment portfolio is investigated. A new approach to systematization of factors of home bias through their clustering for institutional, behavioral, transaction and other factors is suggested.

Are Strategies for International Diversification by Country, Industry and Region Equivalent?

In this study, we examine whether international portfolio diversification still matters despite an increase in the cross-country correlations of assets returns. More specifically, we explain why an increase in global return correlations does not necessarily imply a reduction in the benefits of international portfolio diversification. We also propose to compare empirically two traditional strategies of international diversification (by country and industry) in addition to a new strategy (by region) using two different methodological approaches, namely the mean variance spanning and multivariate cointegration analysis. Over the full sample period (1994- 2008), our results suggest that the three strategies of international diversification remain effective despite the secular increase in the cross-country return correlations. When we divide the sample into two different sub-periods (1994-2000 and 2000-2008), the findings indicate that the strategy based on regional diversification proved to be a new competing strategy during the second period in comparison to the other two traditional strategies.