TY  - JOUR
AU  - Baxter,Marianne
AU  - Jermann,Urban J.
TI  - The International Diversification Puzzle is Worse Than You Think
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5019
PY  - 1995
Y2  - February 1995
UR  - http://www.nber.org/papers/w5019
L1  - http://www.nber.org/papers/w5019.pdf
N1  - Author contact info:
Marianne Baxter
Department of Economics
Boston University
270 Bay State Road
Boston, MA  02215
Tel: 617/353-2417
Fax: 617/353-4449
E-Mail: mbaxter@bu.edu

Urban Jermann
Finance Department
Wharton School of the University of Pennsylvania
3620 Locust Walk
Philadelphia, PA  19104
Tel: 215/898-4184
Fax: 215/898-6200
E-Mail: jermann@wharton.upenn.edu
AB  - Although international financial markets are highly integrated across the more well-developed countries, investors nevertheless hold portfolios that consist nearly exclusively of domestic assets.  This violation of the predictions of standard theories of portfolio choice is known as the 'international diversification puzzle.'  In this paper, we show that the presence of nontraded risk associated with variations in the return to human capital has dramatic implications for the optimal fraction of domestic assets in an individual's portfolio.  Our analysis suggests that the returns to human capital are highly correlated with the returns to domestic financial assets. Hedging the risk associated with nontraded human capital involves a short position in national equities in an amount approximately 1.5 times the value of the national stock market.  Thus optimal and value- weighted portfolios very likely involve a short position in domestic marketable assets.
ER  -