Political and economic events in the 1980s and the 1990s underscored the growing importance of free flows of finance, trade, and investment among countries. These changes, along with an improved ability to collect and analyze data, give us low-cost information about foreign securities. As a result, investors are realizing substantial benefits from international investment. In this chapter, we saw that international stock and bond diversification can yield higher returns with less risk than investment in a single market.
In the past 20 years or so, researchers have convincingly argued, in terms of the mean-variance model, the case for international portfolio investments, as opposed to purely domestic diversification. A major reason for such a case is that international investment offers a broader range of opportunities than domestic investment even in a market as large as the USA or Europe. Studies have stressed the following two points: (1) adding foreign securities to a purely domestic portfolio reduces the total risk of the portfolio because of a low correlation between foreign securities and the domestic market; and (2) in the past, international portfolios could have yielded both a higher return and a lower volatility than purely domestic portfolios.
Even though investors are increasingly interested in foreign securities, investment in foreign securities represents a small portion of their total investment in stocks and bonds. Most commonly expressed barriers to international investment include: (1) excessive information and transaction costs; (2) double taxation of foreign investment profits; (3) foreign-exchange regulations and currency risk; (4) greater rate-of-return volatility; (5) unfamiliarity with operating procedures of foreign stock exchanges; (6) unavailability of high-quality financial data for foreign companies; and (7) significant delays of transactions and settlements associated with foreign securities.
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