Review of Quantitative Finance and Accounting, 16, 311–321, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
A Note on International Portfolio Diversiﬁcation
with Short Selling
RAYMOND W. SO
Department of Finance, Chinese University of Hong Kong, Shatin, Hong Kong
School of Management, Binghamton University, Binghamton, NY 13902-6015
Abstract. In this paper, the diversiﬁcation beneﬁts of using stock index futures are examined. Empirical evidence
shows that traditional diversiﬁcation in international equity markets does not produce a risk adjusted performance
superior to the US market. An explanation for this result is that restrictions on short selling prohibit the best alloca-
tion of resources when overseas stock markets are riskier and have worse returns. However, when such restrictions
are eased for short selling in index futures markets, investors are enabled to both allocate their investments more
efﬁciently and to construct a superior portfolio.
Key words: international investment, portfolio diversiﬁcation, shorting selling, index futures
JEL Classiﬁcation: G11, G15
Since the pioneering work of Grubel (1968), many studies (e.g., Levy and Sarnat, 1970;
Solnik, 1974; Lessard, 1976; and Biger, 1979) have shown that international diversiﬁcation
can result in a lower level of risk for a given level of expected return. In addition, effectiveness
of various international diversiﬁcation strategies have also been examined extensively (e.g.,
Errunza, 1977; Errunza and Padmanabhan, 1988; Eun and Resnick, 1988; and Mathur and
Hanagan, 1983). More recently, Bailey and Stulz (1990), Odier and Solnik (1993), Doukas
and Yung (1993), Chang et al. (1995); Solnik (1995), Akdogan (1996), Michaud et al.
(1996), Solnik (1997) and Grifﬁn and Karolyi (1998) have shown that an internationally
diversiﬁed portfolio is more efﬁcient than other market portfolios in developed markets.
In summary, extant empirical evidence in the past thirty years generally shows that global
diversiﬁcation is a viable strategy to pursue.
Nevertheless, the increasing integration of ﬁnancial markets, and the current superior per-
formance of the US market, challenges the beneﬁts gained from international diversiﬁcation.
Address correspondence to: Raymond W. So, Department of Finance, Chinese University of Hong Kong, Shatin,
Hong Kong. Fax: +(852) 2603-6586, Email: email@example.com