Does It Pay For Australian Investors To Diversify Into Their Country's Major Trading Partners?

Abstract

The benefits of international diversification are well-documented. At the same time, financial markets have become more open and globalised due to the reduction in barriers as a consequence of deregulation and liberalisation of markets, and the advent of new technologies, which have occurred since the 1980s. Thus, international diversification provides opportunities for Australian investors to earn higher risk-adjusted returns. A group of countries that can be considered immediately as candidates for this activity would be Australia's major trading partners since these are countries whose equity markets have grown rapidly over the last two decades. However, there is a need to investigate whether indeed it would benefit Australian investors if they diversify into these markets. Lately, due to the increasing integration of markets, there has been evidence that markets have become more correlated and therefore one wonders whether the international diversification gains would still be there. We therefore investigate this issue in this study. We determine the size of the benefits for an Australian investor diversifying into the equity markets of the US, UK, Japan, Hong Kong, Singapore, Korea, China and Indonesia during the period 1993 to 2003. We utilise a Markowitz mean-variance analysis with parameters estimated based on a bootstrap methodology. Our results show that international diversification into these markets still pays for Australian investors.