International Portfolio Diversification for European Countries : The Viewpoint of Hungarian and German Investors

In this paper, we study the benefits derived from international diversification of stock portfolios from Hungarian as well as German point of view. The Hungarian Stock Exchange is an emerging market in contrast to the German capital market which is one of the largest markets in the world. In an ex post perspective the benefits from internationally diversified portfolios for Hungarian investors accrue only in terms of reduction in risk while for German investors also in terms of higher expected returns. By examining the performance of several ex ante strategies the paper also presents evidence on the benefits from international diversification for both countries. The strategies considered are the equally weighted (EQW), the minimum variance (MVP), the tangency (CET) and an equally risky portfolio as the domestic one (ERP). To evaluate the performance of the strategies, portfolio adjustment costs are taken into consideration. Because of the instability of sample mean returns, the Bayes-Stein transformation was applied to estimate the expected returns on portfolios. A theoretical finding of this paper is that in the case of our ERP strategy the Bayes-Stein estimation gives the same portfolio weights as the sample mean vector. So, no improvement in portfolio performance could be expected by combining the Bayes-Stein estimation technique with the ERP strategy