Long-term diversification benefits across global industries : an empirical analysis of international return correlations

Abstract

This thesis contributes to the field of global capital allocations by examining the benefits of portfolio diversification across global equites, government bonds and industries for longhorizon investors over time. We use a vector autoregressive (VAR) model and a log-linear asset pricing framework to decompose global asset return correlations into cross-country correlation of cash flow shocks and discount rate shocks. Cash flow shocks are empirically shown to have persistent effects on prices, and therefore affect portfolio risk at all investment horizons. Conversely, discount rate shocks are shown to have only a transitory impact on valuations and portfolio risk, implying that it only affects short-horizon investors. We confirm the findings of Viceira and Wang (2018) that global equity portfolio diversification benefits have not declined for long-horizon investors, while investors in global bond markets have experienced a worsening of portfolio diversification benefits at all investment horizons. Our main contribution is to study the evolvement and implications of differences in asset return correlations across ten global equity industries. We find differences between the industries with respect to their impact on global portfolio diversification benefits over time. Consequently, investors may obtain substantial improvements in portfolio risk by investing in certain industries. Our findings thus expand on existing literature that primarily examines the diversification benefits across the market as a whole.