Why Diversify Internationally When Domestic Diversification Provides Similar Benefits?

In light of investor "home-bias" and recent changes in the characteristics of equity markets around the world, this paper appraises the potential benefits of domestic equity diversification, as an alternative to international diversification. We construct forward-looking "home-made" diversification portfolios to imitate each of thirty-seven foreign equity indices and a world portfolio over a ten-year period. The results show that it is possible to mimic foreign indices with domestic equity assets more than previously reported. The differences in pay-offs from international and domestic portfolios are statistically and economically insignificant. Therefore, investors are not compensated for extra risks attached to international diversification.