The Indirect Diversification Benefits of Investing in Japanese Firms: An Alternative Perspective

Abstract

This paper examines the role of firm-level multinationality in equity portfolio diversification for Japanese firms from 1998 to 2015. We use a unique multinationality dataset for constituents of the Nikkei 225 based on two measures of sales and subsidiaries. We employ an extended version of the traditional Capital Asset Pricing Model (CAPM) to analyse the exposure of firm returns to various geographical regions. There is evidence that firms are not influenced by the geographic regions where they report operations. The results also indicate that there are benefits from investing in Japanese multinationals but these benefits do not increase with increasing multinationality. A new category of firms is identified that may be beneficial to investors—firms that are influenced by a geographical region where they do not report sales or subsidiaries. This finding has far reaching implications for portfolio management. Investors must do more than analyse the international location of firm operations. They must analyse the geographical influences on firm returns. Existing studies fail to distinguish between these two criteria, assuming them to be the same. We find evidence to the contrary.