Macroeconomic Factors and their role in Moderating Diversification effect of Asset Classes in the EU

After the 2008 financial crisis, some have questioned the historically positive benefits ofdiversification, meanwhile others have stated a clear misunderstanding of whatdiversification entails. This study argues diversification is still viable in portfolio theory,and that more effort should be emphasized on macroeconomic factors’ role in theoptimal portfolio. According to the Rational choice theory, investors want to reduce riskwithout lowering expected returns. Modern portfolio theory believes it is possible to doso, by combining less-than-perfect correlated asset classes in a portfolio. The businesscycle theory adds a further perspective by considering cycling movements in themacroeconomic environment, which this study ties to the correlation of asset classes.This study enriches the range of macroeconomic factors and asset classes, focusing onthe EU area, and subsequently, identifies existing relationships. Hence, the researchquestion, “Do macroeconomic factors moderate diversification effect across assetclasses in the EU?” is answered.Results are achieved through the positivist paradigm and the deductive researchapproach, and further, a panel data analysis including 18 macroeconomic factors and 8asset classes during the 2013 to 2022 time periods. The OLS single regression model isused, and results are compared to the previous literature.The characteristics of these 70 relationships are presented. Further, the level of impactfor 18 macroeconomic factors is ranked, the unemployment rate is the most impactfulfactor and GDP impact on gross public debt is the least impactful factor. An investor'sperspective is kept during the thesis to inspire professional investors, especiallyportfolio managers to be detail-oriented when they design diversification strategies andconstruct the optimal portfolios. Also, the results regarding institutional quality indexesincrease the importance of the social and sustainable segment of macroeconomicfactors, which should be considered by investors in the future. Ultimately, this studycontributes to previous literature by examining the empirical results through the lens ofRational choice theory, Business cycle theory, and Modern portfolio theory