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Geographic Versus Industry Diversification: Contraints Matter

Authors
Paul EHLING - Penn State University, Smeal College
Sofia B. RAMOS - ISCTE Business School

Date
August 2004

Click here to download a .pdf of this paper (1'842 KB).

Abstract
This research addresses whether geographic diversification provides benefits over industry diversification in a sample of European country and industry indexes. The methodology allows performance comparisons with short-selling constraints, upper and lower bounds, and many benchmarks. In the absence of constraints, no empirical evidence is found to support the argument that country diversification is a superior approach. In the case of realistic weights on portfolios such as short-selling, and lower or upper bonds, geographic diversification performs (sig-nificantly) better. The contrary results appear to be attributable to the fact that industry portfolios are better suited to eliminate the single dominant factor risk in stock returns. Further out-of-sample analysis shows that geographic diversification performs better, although the tests do not show statistical significance.

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