Assessing the impact of short-sale constraints on the gains from international diversification

Abstract: This paper examines the impact of short-sale constraints on the magnitude of international diversification benefit for U.S. investors during the period of 1976?1998. The diversification benefit is measured as the increase in expected return when switching from the U.S. equity index portfolio to the efficient international portfolio with equal variance. Although short-sale constraints reduce the diversification benefit, we find that the reduction caused by the constraints on emerging markets is small. This result holds in both pre- and post-liberalization periods. They are also unaffected by the fact that the U.S. index portfolio is not on the efficient frontier spanned by U.S. securities.

Keywords: diversification benefit; efficient international portfolio; equity index portfolio; diversification; investing;

JEL Classification: G15; G11; G12;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 1999-10-01

Number: 89

Pages: 47 pages

Note: For a published version of this report, see Asani Sarkar and Kai Li, "Should U.S. Investors Hold Foreign Stocks?" Current Issues in Economics and Finance 8, no. 3 (March 2002).