Can Investors Benefit from International Diversification without Trading Abroad?

This paper examines whether investors can benefit from international diversification without trading abroad. This study uses monthly return data from 1988 to 2003 for S&P 500 Index, Lehman Brothers U.S. Aggregate Bond Index, MSCI ACWorld ex U.S Index and DJIA Index. The original return correlations, skewness and kurtosis, Sharpe performance measure, and QOS-15 optimization reports provide strong evidence that gains beyond those attainable through homemade diversification have become statistically and economically insignificant. However, the extreme portfolio weights in this optimization indicates that the asset with the higher expected return like the DJIA Index dominates the optimization, and clouds the effect of correlations which are far more relevant to my study. As such, I adopt two corrections that are motivated by a "reverse optimization" approach suggested by Sharpe (2002). The corrected findings do not support EHH's conclusion, that is, trade abroad is still necessary to gain the benefits of international diversification.