International Portfolio Investing: Common Misconceptions

International Portfolio Investing

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Question

Which of the following statements about international portfolio investing is FALSE?

Answers

A. The majority of risk for individual foreign country markets is unsystematic.

B. When markets are volatile, global diversification is of increased value.

C. Barriers to international diversification include lack of liquidity, currency controls, and exchange rate risk.

D. While the introduction of foreign stocks ("second layer") into a domestically-only diversified portfolio shifts the efficient frontier up and left, adding a "third layer" of foreign bonds shifts the efficient frontier even more up and left.

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Explanations

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A. B. C. D.

When markets are volatile, global diversification is of limited value. Studies show that correlations between markets increase as market volatility increases, which limits the benefits of diversification. In particular, studies show that correlations increase when markets are falling.

The other statements are true. Although foreign exchange risk is not considered a factor that impacts correlations, it is a significant barrier to international investing.

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