Copyright © 2007 Pearson Addison-Wesley. All rights reserved. Copyright © 2007 Pearson Addison-Wesley. All rights reserved.
Chapter 17
International Portfolio
Theory and
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-2
International Diversification
and Risk
• The case for international diversification of portfolios can be
decomposed into two components, the first of which is the potential risk reduction benefits of holding international securities.
• This initial focus is on risk.
• The risk of a portfolio is measured by the ratio of the variance of a portfolio’s return relative to the variance of the market return
(portfolio beta).
• As an investor increases the number of securities in a portfolio, the portfolio’s risk declines rapidly at first, then asymptotically
approaches the level of systematic risk of the market.
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-3 Number of stocks in portfolio
10 20 30 40 50
By diversifying the portfolio, the variance of the portfolio’s return relative to the variance of the market’s return (beta) is reduced to the level of systematic risk -- the risk of the market itself.
Systematic
= Variance of portfolio return Variance of market return
100
