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International Portfolio Diversification - Essay Example
Finance & Accounting
Pages 11 (2761 words)
This paper examines how International portfolio diversification can result in a reduction in portfolio risk. It looks at various elements of risk that are associated with portfolio. It looks at market returns in five countries and shows how correlation between these markets can impact negatively on portfolio risk reduction. An analysis is also carried out to determine whether of the returns on stock markets in Japan and Canada are integrated based on their trade relationships over the years. …
Investing on the stock market can be a very risky venture. According to Yavas (2007), both the Capital Asset Pricing Model (CAPM) and the Modern Portfolio Theory (MPT) indicates that investors should hold a well diversified portfolio in order to reduce risk. Beta is used to measure risk. A stocks beta indicates the sensitivity of the stock’s returns to the market returns (Madura 2006, p. 304). Madura (2006, p. 304) states that investors who have a diversified portfolio use beta to determine how well their portfolio reflects movements in the market. Investors believe that favourable characteristics that are related specifically to a particular firm will offset unfavourable characteristics of other firms. This is also true for industries and so it implies that a wide range of stocks spanning various industries should be held. It is expected that certain factors affecting securities on the stock market are either firm or industry specific and so in order to reduce unsystematic risk holding securities from a wide range of industries is recommended. This is also true in relation to national securities. Certain risks are country specific and so in order to reduce risk international portfolio diversification is recommended. ...
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