ON THE INTERNATIONALIZATION OF PORTFOLIOS

Portfolio theory has been an important component of open economy macroeconomic models. In such models, it is essential to distinguish between several categories of assets, both foreign and domestic, and to specify their demands and supplies. This framework has become increasingly relevant. Movements of capital across regional and national boundaries and currencies have exploded in volume, thanks to the dismantling of currency and exchange controls and other financial regulations and to revolutionary economies in technologies of communication and transaction. The globalization of financial markets was stimulated by the floating-exchange rate regime established in 1973. Simulations show how opportunities for international diversification affect rates of return on 2 assets: equity claims and risk premia. Optimal portfolio diversification lowers risk premia, as would be expected. But it may seem surprising that it usually also raises the risk-free rate by more than the reduction in the risk of premium, so the rate of return on foreign equity also rises.