Diversification Effects of US Bonds and Global Equities

The purpose of this paper is to study and compare the diversification effects of the investment in the foreign equity market and the U.S. bond market during the U.S. expansion and recession periods. The concept and test methodology are based on the CJJ paper, but expands to a broader area which covers fixed income, further supported with portfolio optimization test. This paper can provide U.S. investors with insights on the ways to diversify their equity portfolio, especially during the U.S. stock market recession periods. Results show that both foreign equities and the U.S. bonds can diversify U.S. equity assets. However, the effect of diversification of the foreign equity market experienced a decrease and is also lower than that of the U.S. fixed-income assets. This result also rationalizes the investing behaviour of “flight to quality”.