Global Diversification 2-2

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Southern New Hampshire University *

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640

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Finance

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Jan 9, 2024

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Globalization of Financial Markets Tristyn Huet-Heart Southern New Hampshire University FIN-640-Q2361 Investment Analysis & Portfolio Management December 17, 2023 Dr. Geoffrey VanderPal

Globalization of Financial Markets Any individual getting started in developing an investment portfolio has a plethora of different decisions to make including the types of investments, risk appetite and whether to invest in domestic and/or international markets. After deciding the level of risk that one is willing to assume, the next decision would be what types of strategy would provide the most benefit short-term and long-term goals of the investor. International and domestic markets provide different benefits, risk exposure, and employ different investment strategies. International vs Domestic Markets International and domestic markets offer investors with the opportunity to create a diversified investment portfolio and hedge against risks that might pertain to one market or the other. One of the primary differences between the two markets is the difference in calculation returns on foreign investments. “The return on a foreign investment is affected by the return on the assets within its own market and the change in the exchange rate between the security’s own currency and the currency of the purchaser’s home country.” (Elton, Gruber, Brown, & Goetzmann, 2014) International markets also differ from domestic markets by having an additional layers of risk exposure including, currency exchange risk, differences in financial reporting standards, political risk, and foreign taxes and regulations. (Consumers Credit Union, 2023) International Securities International securities play a vital role in corporate portfolios. Investors look to add international securities into portfolios in efforts to captivate emerging opportunities, reduce risks and create a diverse portfolio. Considering a real-world example, an analysis of the Chinese capital market compared to the United States market has shown a lot of variability with respect

to the recovery in the economy since the 2020 Covid-19 Pandemic. “ While the pandemic has increased global development risks, led to a rise in protectionism and unilateralism, China has expanded its opening up and actively led the globalization process,” ultimately propelling global economic governance and supporting the confidence in the international finance market. (World Economy News, 2021) Despite other countries, including the United States, struggling to economically recover after the pandemic, China’s economy has stabilized, providing investors with the opportunity to benefit as other global economies are still recovering. “Recent evidence shows that in financial crises, correlation in equity returns goes up and that the risk reduction properties of international diversification are reduced and possibly eliminated in these crashes.” (Elton, Gruber, Brown, & Goetzmann, 2014) An investor with both international and domestic securities would have the benefit of engaging in emerging Chinese market while offsetting the risk exposure of the struggling U.S. market. This scenario provides a prime example of the role that international markets play in corporate portfolios. Risk Levels There are several measures that investors can quantify the risk levels between domestic and foreign securities. Modern portfolio theory (MPT) quantifies investments considerations beyond expected risk and return through the applying a standard deviation to domestic and foreign markets and measuring the correlation coefficients between different countries. Historically, international diversification has provided investors with low-risk portfolios based on the concept of market correlation which says, “that the stocks in one country tend to move together, however, stocks in different countries did not.” (Elton, Gruber, Brown, & Goetzmann, 2014) The variability of the movement in stocks between different countries can be

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