The strength and source of asymmetric international diversification

We find that correlations between international markets continue to increase over time compared to previous research, with only Asian markets providing lower correlations relative to American and European markets. Consistent with previous studies, the benefits from international diversification are asymmetric, with reduced diversification benefits during bear markets. We extend previous results by examining the characteristics and causes of the returns affecting these asymmetric correlations, relating these results to the herding behavior of investors across markets rather than to fundamental economic reasons. Specifically, we determine that the increase in correlations among markets is most closely associated with the larger correlations from the largest positive return time intervals in bear markets rather than the negative returns. Use of stock index futures avoids issues inherent in the use of international cash indexes.