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This paper examines whether the widely reported phenomena of home and foreign biases (i.e. suboptimal international equity portfolio diversification) hold any ramifications for the development of stock markets. The results, analysed using macro- and micro-level data, support the view that stock markets that are characterised by a higher degree of home bias are associated with lower levels of development. On the other hand, markets where foreign investors show a higher degree of allocation preference, relative to the prescribed benchmark (foreign bias), are found to be more developed. The results, which are robust to the use of shock based identification strategy, indicate that policy measures that promote optimal international equity portfolio diversification could be crucial in developing the depth and breadth of domestic stock markets.

Recent literature draws attention to the issue of whether heterogeneity in investment horizons has an effect on resulting investor exposures. In this article, using Malaysia as a case study, we make the first attempt to examine comovement dynamics of Islamic equity returns to identify international portfolio diversification opportunities for investors having heterogeneous investment horizons. We use three recent and appropriate methodologies: M-GARCH-DCC, Continuous Wavelet Transforms (CWT), and Maximum Overlap Discrete Wavelet Transform (MODWT). The results significantly tend to indicate that effective portfolio diversification opportunities between our sample markets exist mainly for short holding periods while for longer investment horizons, where investor stockholding periods exceed one year, the markets appear to be mostly highly correlated yielding minimal portfolio diversification benefits. Overall, the results critically highlight the significance of heterogeneity in investment horizons and bear important implications for portfolio diversification strategies.

Purpose The purpose of this paper is to quantify the extent to which the Malaysia-based equity investors can benefit from diversifying their portfolio into the conventional and Islamic Southeast Asian region and the world’s top ten largest equity indices (China, Japan, Hong Kong, India, the UK, the USA, Canada, France, Germany and Switzerland). Design/methodology/approach The multivariate GARCH-dynamic conditional correlation is deployed to estimate the time-varying linkages of the selected conventional and Islamic Asian and international stock index returns with the Malaysian stock index returns, covering approximately eight years daily starting from 29 June 2007 to 30 June 2016. Findings In general, in terms of volatility, the results indicate that both Asian and international Islamic stock indices are more or less volatile than its conventional counterparts. From the correlation analysis, we can see that both the conventional and Islamic MSCI indices of Japan provide more diversification benefits compared to Southeast Asian region, China, Hong Kong and India. Meanwhile, in terms of international portfolio diversification, the results tend to suggest that both the conventional and Islamic MSCI indices of the USA provide more diversification benefits compared to the UK, Canada, France, Germany and Switzerland. Originality/value The findings of this paper may have several significant implications for the Malaysia-based equity investors and fund managers who seek for the understanding of return correlations between the Malaysian stock index and the world’s largest stock market indices in order to gain higher risk-adjusted returns through portfolio diversification. With regard to policy implications, the findings on market shocks and the extent of the interdependence of the Malaysian market with cross-border markets may provide some useful insights in formulating effective macroeconomic stabilization policies in the efforts of preventing contagion effect from deteriorating the domestic economy.

Household investment mistakes are an important concern for researchers and policymakers alike. Portfolio underdiversification ranks among those mistakes that are potentially most costly. However, its roots and empirical importance are poorly understood. I estimate quantitatively meaningful diversification statistics and investigate their relationship with key variables. Nearly all households that score high on financial literacy or rely on professionals or private contacts for advice achieve reasonable investment outcomes. Compared to these groups, households with below-median financial literacy that trust their own decision-making capabilities lose an expected 50 bps on average. All group differences stem from the top of the loss distribution.

We evaluate the out-of-sample performance of the sample-based mean-variance model, and its extensions designed to reduce estimation error, relative to the naive 1/N portfolio. Of the 14 models we evaluate across seven empirical datasets, none is consistently better than the 1/N rule in terms of Sharpe ratio, certainty-equivalent return, or turnover, which indicates that, out of sample, the gain from optimal diversification is more than offset by estimation error. Based on parameters calibrated to the US equity market, our analytical results and simulations show that the estimation window needed for the sample-based mean-variance strategy and its extensions to outperform the 1/N benchmark is around 3000 months for a portfolio with 25 assets and about 6000 months for a portfolio with 50 assets. This suggests that there are still many \"miles to go\" before the gains promised by optimal portfolio choice can actually be realized out of sample.

This study examines the integration of nine Asian stock markets using the new methodology of wavelet multiple correlation and multiple cross-correlation proposed by Fernandez (2012). This novel approach eliminates several limitations which are encountered when conventional pairwise wavelet correlation and cross-correlation are used to assess the comovement of a set of stock indices. Our results show that Asian stock markets are highly integrated at lower frequencies and comparatively less integrated at higher frequencies. From the perspective of international investors, the Asian stock markets therefore offer little potential gains from international portfolio diversification especially for monthly, quarterly, and bi-annual time horizon investors, whereas, higher potential gains are expected at intraweek, weekly, and fortnightly time horizons.

We present a model of shadow banking in which banks originate and trade loans, assemble them into diversified portfolios, and finance these portfolios externally with riskless debt. In this model: outside investor wealth drives the demand for riskless debt and indirectly for securitization, bank assets and leverage move together, banks become interconnected through markets, and banks increase their exposure to systematic risk as they reduce idiosyncratic risk through diversification. The shadow banking system is stable and welfare improving under rational expectations, but vulnerable to crises and liquidity dry-ups when investors neglect tail risks.

If an investor wants to form a portfolio of risky assets and can exert effort to collect information on the future value of these assets before he invests, which assets should he learn about? The best assets to acquire information about are ones the investor expects to hold. But the assets the investor holds depend on the information he observes. We build a framework to solve jointly for investment and information choices, with general preferences and information cost functions. Although the optimal research strategies depend on preferences and costs, the main result is that the investor who can first collect information systematically deviates from holding a diversified portfolio. Information acquisition can rationalize investing in a diversified fund and a concentrated set of assets, an allocation often observed, but usually deemed anomalous.

Using new data for the universe of firms covered in Amadeus, we reconstruct the portfolios of shareholders who hold equity stakes in private- and publicly traded European firms. We find great heterogeneity in the degree of portfolio diversification across large shareholders. Exploiting this heterogeneity, we document that firms controlled by diversified large shareholders undertake riskier investments than firms controlled by nondiversified large shareholders. The impact of large shareholder diversification on corporate risk-taking is both economically and statistically significant. Our results have important implications at the policy level because they identify one channel through which policy changes can improve economic welfare.

This paper features an analysis of the effectiveness of a range of portfolio diversification strategies, with a focus on down-side risk metrics, as a portfolio diversification strategy in a European market context. We apply these measures to a set of daily arithmetically-compounded returns, in U.S. dollar terms, on a set of ten market indices representing the major European markets for a nine-year period from the beginning of 2005 to the end of 2013. The sample period, which incorporates the periods of both the Global Financial Crisis (GFC) and the subsequent European Debt Crisis (EDC), is a challenging one for the application of portfolio investment strategies. The analysis is undertaken via the examination of multiple investment strategies and a variety of hold-out periods and backtests. We commence by using four two-year estimation periods and a subsequent one-year investment hold out period, to analyse a naive 1/N diversification strategy and to contrast its effectiveness with Markowitz mean variance analysis with positive weights. Markowitz optimisation is then compared to various down-side investment optimisation strategies. We begin by comparing Markowitz with CVaR, and then proceed to evaluate the relative effectiveness of Markowitz with various draw-down strategies, utilising a series of backtests. Our results suggest that none of the more sophisticated optimisation strategies appear to dominate naive diversification.