The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Friday, August 03, 2007

International Investing and China in the NBER Digest

I came across a couple of interesting items in the July issue of the National Bureau of Economic Research's NBER Digest.

The first item that caught my eye was The Declining Gain from International Portfolio Diversification (by Les Picker). That article describes a NBER Working Paper by Karen Lewis, a financial economist at Wharton, where she examines the puzzle of why investors tend to disproportionately weight their investment portfolios to domestic securities and assets. This tendency is a 'puzzle' because this tendencymeans that investors forego the possible gains -- including lower correlated risks, higher returns from riskier foreign investments, etc. -- from international diversification.

Prof. Lewis finds that (a) international equity markets have become more correlated over the years (although she didn't find them to be as highly correlated as others have suspected them to be), and (b) foreign stocks that are listed on U.S. exchanges have become highly correlated with the U.S. market(s) over time. Thus, the potential gains from international portfolio diversification have been declining, and there seems to be relatively little to be gained in the way of diversification from investing in domestically listed foreign stocks.

The second item of interest in the NBER Digest is The Return to Capital in China (also by Les Picker). This article discusses research by professors Bai, Hsieh, and Qian, on what affects (if any) China's high investment rate (over 40% of GDP) has on returns to capital. The researchers found that (adjusted for various factors) China has relatively high returns to capital. It should be noted that this is an interesting finding because high investment rates can often mean lower returns to capital.

One of the plausible reasons why China's return to capital seems to be higher is -- despite misallocation of capital in many cases -- that China's economy has been moving rapidly toward more capital-intensive industries and techniques and away from purely labor-intensive industries of the past.

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